Rates Need to Stay Put After Inflation Inches Up

Australia’s inflation rate, at 1.7% in the September quarter, edged slightly closer to the Reserve Bank of Australia’s official target range of 2-3%. The unemployment rate dipped to 5.2% in September, while real wage growth remains low at 0.7%. The RBA Shadow Board’s conviction that the cash rate should remain at the new, low rate of 0.75% equals 64%, while the confidence in a required rate cut is 8% and the confidence in a required rate hike 27%.

Based on ABS figures for September, the seasonally adjusted unemployment rate in Australia ticked down to 5.2%, in line with a minute drop in the labour force participation rate to 66.1%. Total employment rose by nearly 15,000, while full time employment increased by more than 26,000. Wages growth data, a keenly awaited number, is to be released in a fortnight.

The Aussie dollar rebounded after recent lows and is currently buying around 69 US¢. Yields on Australian 10-year government bonds also rebounded after recent lows, to around 1.1%. The yield curve remains inverted in short- and medium-term maturities (2-year versus 1-year and 5-year versus 2-year) but less so than in previous months. The Australian share market has remained largely range-bound in October; the S&P/ASX 200 stock index now trades near 6,650.

Forecasts for the global economy are weakening, according to the IMF. Growth in 2019 will be the weakest since the 2008 global financial crisis. The IMF forecasts China’s growth will fall from 6.1% this year, to 5.8% in the next year. US growth is also predicted to be substantially lower than in 2018, thus shaving 0.8% off global GDP growth. According to the IMF the US-China trade war is costing both countries: it concluded the trade war has reduced US wealth by 0.6% and a continuation of the trade war is predicted to cost China 2% of GDP. Other downside risks to the global economy remain, from violence and instability in the Middle East and political conflict in Europe to financial stability concerns associated with a protracted period of low interest rates and excessive risk taking.

Consumer confidence, as measured by the Melbourne Institute and Westpac Consumer Sentiment Index, dropped noticeably from 98.2% in September to 92.8 in October. According to the most recent data available (August) retail sales expanded by 0.4% (month-on-month). Business confidence (NAB) remained flat while the manufacturing PMI appears range-bound within 50-55; the services PMI, too, is moving sideways. The capacity utilisation rate, after spiking to 82.04% in August, fell slightly.

The housing market appears to consolidate a little, at least temporarily, possibly as a consequence of the recent cuts in mortgage rates. Building permits increased by 7.6% (month-over-month) in September. The construction PMI fell slightly from 44.6 in August to 42.6 a month later. The number of new home loans for owner-occupied homes rose 1.8%, beating market expectations by a big margin. It was the highest figure in 9 months. Clearance rates, according to CoreLogic, have also increased noticeably. The concern remains that a recovery of the housing market further exacerbates household indebtedness and thus increases macroprudential risks down the track.

After the Reserve Bank of Australia’s rate cut last month, the Shadow Board now attaches a 64% probability that the overnight interest rate should remain at 0.75%. It attaches an 8% probability that a rate cut, to 0.5%, is appropriate and a 27% probability that a rate rise, to 1% or higher, is appropriate.

The probabilities at longer horizons are as follows: 6 months out, the estimated probability that the cash rate should remain at 0.75% equals 36%. The probability attached to the appropriateness for an interest rate decrease stands at 26%, while the probability attached to a required increase equals 39%. One year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 32%, while the confidence in a required cash rate decrease equals 23% and in a required cash rate increase 46%. The range of the probability distributions over the 6 month and 12 month horizons has narrowed, extending from 0.25% to 1.75%.