Australian Markets Weekly: A new easing cycle, the effective lower bound, unconventional policy & forward guidance

The RBA is expected to cut the cash rate on Tuesday, with a follow-up cut expected in August.

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For the full picture, download the report – Australian Markets Weekly 3 June 2019.

 

  • The RBA is expected to cut the cash rate on Tuesday to a new record low of 1.25%.  We expect a follow-up cut in August, with the risk of additional stimulus by early 2020.  The depth of the easing cycle ultimately delivered by the RBA will depend on: (1) the extent of the slowdown in the economy; and (2) the bank’s assessment of the stance of policy, relative to its view of the neutral cash rate.  The RBA has reduced its midpoint estimate of the neutral rate from 5% prior to the global financial crisis to 3.5% in 2017 and we think it could soon trim it to 3-3.25% given lower potential growth and a wider spread between mortgage rates and the cash rate.
  • If the economy turns out worse than we expect, a typical easing cycle would quickly exhaust the RBA’s capacity for rate cuts given it has previously put the effective lower bound at 1%, plus or minus a bit.  This would bring unconventional policy into play, where the RBA’s 2016 study of international experience suggests combining options may yield better results than adopting a single policy at a time. That said, the RBA may first opt to expand its balance sheet given the temporary increase in the RBA and Commonwealth’s balance sheets proved successful during the global financial crisis.  The RBA cautioned, though, that its adoption of unorthodox policies would likely be reactive rather than pre-emptive.
  • Regardless of whether the downside scenario that could trigger unconventional policy is realised, we think the RBA might take more steps in providing forward guidance at the current low level of interest rates, building on its use of scenarios in its commentary and reliance on market pricing of rates in preparing its economic forecasts.

The week ahead – RBA expected to cut; US-China trade tensions worsen

  • The RBA meets on Tuesday and Q1 GDP is released on Wednesday. NAB and the market both expect the RBA to cut the cash rate by 25bp to 1.25%. Although the accompanying press release will likely concentrate on the June decision, we think Governor Lowe could outline a scenario for further easing in when he speaks that night.  The RBA’s Alex Heath is speaking on Wednesday on Australia’s resource industry.  Balancing recent weak partials and likely positive indicators on Monday and Tuesday, NAB expects a 0.4% q/q / 1.7% y/y result (mkt: 0.5%) for GDP.  NAB forecasts unusually weak retail sales, falling 0.3% in April (mkt: 0.2% m/m).
  • Offshore, trade tensions dominate. The US announced last week that it might impose tariffs on Mexico, while China introduced tariffs on $US60b of imports from the US and announced a probe into FedEx.

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