NAB Change to Rate Call – May 2019

RBA to cut in June with a risk it eventually cuts below 1%.

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  • We have changed our view on the cash rate, bringing forward the timing of forecast rate cuts to start in June.  Previously, we had forecast the RBA to cut the cash rate by 25bp in July and again in November, taking the cash rate to 1%. We now expect the RBA to cut at the 4 June Board meeting and again in August. We also see a risk that the RBA delivers additional policy stimulus by early 2020, either by cutting again or opting for an alternative policy measure.
  • Yesterday’s labour force data provided further evidence that the economy is weaker than the RBA had expected.  The unemployment rate has risen from an eight-year low of 4.9% in February to 5.2% in April.  Although employment has remained strong, other measures point to increased spare capacity over recent months, while forward indicators of the demand for labour have turned down, except for the less timely ABS job vacancies series.
  • With underlying inflation almost back at the multi-decade low reached in 2016, the RBA said in its May cash rate decision that “a further improvement in the labour market was likely to be needed for inflation to be consistent with the target”, where the Board would be “paying close attention to developments in the labour market at its upcoming meetings”. Given low inflation, continued weakness in the NAB business survey – where NAB’s internal indicators point to the weakness in spending becoming entrenched – and now higher unemployment, we think the Board will now act in June and that this is likely to be signalled in the May Board minutes and Governor Lowe’s speech on Tuesday.
  • The timing of a follow-up cut will depend on the flow of the data, but we have now brought forward the second cut to August, taking the cash rate to 1%.  This will allow the Board to gauge the initial reaction to the first cut, while the RBA will update its outlook based on Q1 GDP (released 5 June), the Q2 CPI (31 July), two more labour force surveys and further reads on the economy from the NAB business survey.
  • We have previously noted that further policy adjustment may be required and we highlight the risk the RBA will deliver additional policy stimulus by early 2020. This could be in the form of a further rate cut, taking the cash rate below 1%, or consideration of an alternative policy measure to support the economy. The case for additional stimulus stems from the RBA’s need to reduce real interest rates, an objective that is frustrated by low actual and underlying inflation.  This view is reinforced by our updated outlook, where we think that the RBA is overly optimistic on growth with a weaker labour market likely to see inflation undershoot the 2-3% target band until mid 2021 (see The Forward View – Australia, 15 May).

For further details, please see the NAB Change in cash rate call – May 2019.