Bassanese's Market Insights: case for February rate cut weak | BetaShares

Bassanese’s Market Insights: case for February rate cut weak

BY David Bassanese | 27 January 2015
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Despite the surprise decision by the Bank of Canada to cut interest rates this week, the case for a corresponding Reserve Bank of Australia interest rate cut at its next policy meeting on Tuesday, February 3 is not especially strong.  Our view is based on several factors – the most important of which is that the labour market could already be turning around.lab1

  • The surprise drop in the unemployment rate to 6.1% in December could be an aberration, but it is consistent with the much earlier upturn evident across a range of forward looking labour market indicators over the past year. The ANZ Job advertisements series, along with the NAB and Dunn & Bradsheet’s respective employment indices have all been moving higher for some time.  Annual growth in non-farm GDP – another key leading indicator of employment – has accelerated from around 2% over 2013, to a near-trend 3% pace by mid-2014.
  • The $A is much more competitive, and further weakness seems likely.  On a trade-weighted basis, the $A has dropped by 7.7% since late September. That said, the $A still seems a little overvalued relative to the decline in commodity prices, the price trend still appears downward and further weakness seems likely as the US inches toward raising official interest rates. A weaker $A should boost inflation over the next few quarters, and should help to boost sentiment among trade-exposed industries.

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  • Weaker oil prices should help consumer sentiment and spending.  Although Australia is a net-energy exporter – with firms hurt by weakness in coal and LNG prices – we are a net-importer of oil. That means the near 50c drop in petrol prices over the past six months should be saving the average household around $15 per week (assuming an average purchase of 30 litres) or 2% of after-tax income. While the bounce in consumer sentiment has so far been modest, it’s premature to believe there will be little impact – especially if oil prices fall further.

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  • Housing demand remains firm.  While affordability constraints may be starting to cool demand in some hot pockets of the established housing sector, underlying demand for new homes remains solid. Home building approvals surged 7.5% in November, led by investor interest in multi-units. According to the Housing Industry association, new home sales rose further in November, and demand for units especially remains solid.

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  • The RBA’s bark may be as good as its bite. Rather than suddenly cutting rates in February (with little warning), the RBA might be able to just as easily support consumer sentiment, should it desire, without actually cutting rates at all.  It could potentially achieve this outcome by changing the tone of its statements.  If next week’s December quarter CPI report is benign, for example, the RBA could simply revert to its previous rhetoric, which suggested low inflation leaves it with “scope to ease policy further, should that be necessary to support demand”.
  • The RBA should save its ammunition, as it may be needed later.  Due to weak commodity prices and falling mining investment, the economy still faces significant challenges.  Leaving interest rates steady for now would leave the RBA better flexibility to respond more forcibly to demand weakness later should that be needed.

2 Comments

  1. With the devaluation of the A$ would not the RBA Board wait until the March Qtr accounts be for they make a decision on interest rates As you have said the A$ has fallen in value by 7.7% would that have a impact on imported goods and could that have upward pressure on inflation in the second half of the year If the RBA moved too early on lowering interest rates they may have to raise rates quicker than if they had waited say another quarter to better understand where inflation was going Just a thought I’m no economist Everyone seems to be talking about an interst rate cut but I am not reading anything on what the devaluation of A$ will have on inflation Yes fuel has comedown in price but that is another story and different reasons What about vehicle medical supplies clothing etc how will that impact cost pressures

    1. David Bassanese  |  January 28, 2015

      Hi Frank. Good points.. yes the assumption seems to be that the weaker $A will have little impact on inflation due to global dis-inflationary pressures. Maybe, but there are also lags involved before cost increases are passed on. I suspect we’ll see some flow though over the coming year, pushing core inflation back to 2.75% or so. The bigger issue for me is cutting rates even further when economy not in crisis and seems to be chugging along .. a little threat of deflation thus far..

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