Bassanese’s Market Insights: RBA to cut to 1.5%, $A heading for US68c | BetaShares

Bassanese’s Market Insights: RBA to cut to 1.5%, $A heading for US68c

BY David Bassanese | 16 February 2015
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Given the Reserve Bank of Australia’s demonstrated concern over economic growth, we now expect the Bank to cut the official cash rate to 1.5% p.a. by late 2015. The next interest rate cut seems likely next month.   Together with our view that the United States Federal Reserve will begin raising interest rates by mid-2015 – and ongoing likely weakness in  commodity prices – we now see the $A falling to US68c by year-end.

non-mininginv

Here’s why..

Non-mining investment to remain weak

The key factor behind our interest rate call is the expectation that the RBA’s hoped for rebound in non-mining investment will continue to disappoint.  As seen in the chart above, the recovery in non-mining investment since the global financial crisis downturn has been very sluggish by historical standards. The RBA has been counting on this recovery gathering pace so as to offset the economic impact of the mining investment downturn.

In its February Statement on Monetary Policy released last week, the RBA downgraded its economic growth forecasts largely because of a delay in the expected recovery in non-mining investment. In turn, the RBA’s pessimism stemmed from an only modest upgrade to non-mining investment expectations in the September quarter Australian Bureau of Statistics capital expenditure (Capex) survey, and a lack of improvement in survey measures of business conditions and capacity utilisation during the December quarter.

Our expectation is that these lead indicators of non-mining business investment will again fail  to show much improvement over the next few quarters, which suggests the RBA may well need to cut its economic growth outlook again and slash interest rates further. Indeed, the jump in the unemployment rate to 6.4% in January adds further pressure on the RBA, and there’s now a very real risk this rate could lift to 7% by year-end.

The stubborn weakness of non-mining investment – despite low interest rates and a cheaper Australian dollar – seems to reflect several structural headwinds, many of which have already been flagged by the RBA[1].  These include a milder than usual investment downturn during the GFC period, a shift in activity toward less capital intensive service sectors, greater consumer caution, and an apparent lengthening in the average lifespan of capital equipment.  We would add that due to lags and high capital costs, manufacturing sector investment seems unlikely to rebound strongly given recent exchange rate weakness, with significant sector restructuring as a result of past exchange rate strength still underway.  A recovery in demand for new commercial property is also being hampered by still high office vacancy rates and the trend toward online sales.

Aussie heading for US68c

Meanwhile, the recovery in the United States economy continues to gather steam, with 257,000 new jobs created in January.  Our long-held view has been that the US Federal Reserve could start to raise interest rates by as early as April, and is unlikely to wait past July. At the same time, the iron ore prices outlook remains weak, with demand from Chinese steel producers still under pressure and high-cost Chinese iron ore miners not yet willing to significantly cut their own supply.  As very low cost producers, Australia’s major iron ore miners are also unlikely to cut back supply anytime soon.

$Avalue

At US 77c, the $A has already fallen a long way in recent months. But in real terms, the $A still remains high relative to its long-run average (US66c) and relative to the decline in commodity prices.  Accordingly, we see scope for the $A to fall to at least US68c over the coming year.

 


[1] Stephen Elias and Craig Evans, Cycles in Non-mining Business Investment. RBA Bulletin December 2014.

9 Comments

  1. Dave I hope your prediction of interest rates going to 1.5% is proven wrong It would mean that the Australian economy is in worse shape than first thought With the mining and energy infrastructure boom coming to a end Low commodity and energy prices hurting government revenue Though one would feel that energy prices will rise in the not to distant future Were will the jobs come from Manufacturing is leaving Australia By 2017 there will be no vehicle manufacturing in Australia Where will the next generation of tradies get trained and then find work The building of Australia’s next generation of Submarines in all likelihood will be given to the Japanese to build The skills base will deminish and it will be very difficult for a future government to award a large scale manufacturing project to a Australian company as the skills will not be here When I was a young lad no skilled work was there if one wasn’t for university or finishing high school Today those opportunities a being lost To the detriment of our young In the northern suburbs of Adelaide youth unemployment is running in the 19%-23% bracket You may be able to get a more accurate figure as it was awhile ago I read those figures Any how that’s enough for today

    1. David Bassanese  |  February 19, 2015

      Hi Frank

      Yes I wish it could be otherwise. I came from Elizabeth so I appreciate how hard to can be in the old manufacturing areas. Regards D

  2. The RBA should have dropped rates at the beginning of 2014. They are too conservative the board should be replaced.

    1. David Bassanese  |  February 24, 2015

      Hi Kim .. not sure I agree.. at the time home demand picking up steam and the RBA still reasonably thought non-mining investment would lift.. with hindsight the economy has not picked up as expected so in that sense could argue the RBA was “wrong”. that said, home prices still a niggling worry in sydeny but the RBA can now leave that problem with APRA and new “macro-prudential” controls to contain investor lending. cheers David

  3. The truth always gets pushed aside too much political correctness

  4. David, for someone who didn’t see the February rate cut you have turned very bearish the Aussie economy. What are some of the data points that caused this sudden big shift in viewpoint?

    1. David Bassanese  |  February 19, 2015

      Hi Joshua

      I have long had a bearish view on the economy but had taken the RBA at its word that it felt there was little more it could do and would keep rates on hold hoping for recovery. In the AFR in November I argued the bias on rates remained to the downside. That said, I also considered there to be mixed indicators on the economy – such as rising ANZ Job ads.

      My view change reflects new RBA thinking – namely that it concedes its medium term forecast have the economy continuing to grow below trend. It also thinks we need to see an improvement in indicators to prevent a rate rate – rather than further weakness to justify it. Given my view that the economy will remain soft, that suggest the RBA wil need to cut further based on its new thinking. One more cut won’t be enough, especially if the $A stays above US75 and the unemployment rate pushed through 6.5%. Cheers

  5. I recently read an article you wrote back in November David, I think it was for IFA magazine or Money Management (one of those financial planning industry magazines anyway), where you expressly stated that you expected the RBA to be raising interest rates in 2015. Do you think this prediction will be more accurate than that one?

    I ask only to really point out the perils (folly?) in forecasting. I know you have to (it’s your job after all), but perhaps it may be better to talk in terms of probabilities rather than absolutes.

    1. David Bassanese  |  February 20, 2015

      Hi Steve

      Yes forecasting is never easy. My earlier call was not held with strong conviction.. I really was focused on rates on hold for the foreseeable future.. meaning next move then eventually up.. the article you refer to what produced some time ago..

      in keeping with your request, let’s say risk on rates now firmly to the downside.. good probability of rates sub-2% this year. cheers David

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