Rate outlook change
We are changing our call that the RBA will leave the cash rate unchanged at 1.00% through the remainder of 2019 and 2020 and now expect the RBA to cut the cash rate 25bps to 0.75% either in October or November as well as the possibility of a further 25bps rate cut to 0.50% in February 2020. The reasons for the change in our view are the evidence of continuing (possibly building) excess capacity in the labour market; more signs that the Government is resistant to providing fiscal stimulus to the economy; and more signs of moderating growth in Australia’s major trading partner, China. The need for a lower Australian dollar exchange rate in a slower growing global economy is also another reason for our rate call change.
Taking first the evidence of excess capacity in the labour market while employment growth remains strong (up 34,700 in August, more than double market expectations), this latest monthly reading also confirms the trend over the past year or so of even more people joining the workforce each month. The labour force participation rate made a record high 66.2% in August up from 66.1% in July and 65.7% in August 2018. The unemployment rate edged up under 0.1 percentage to 5.3% in August and while that is unchanged compared with August last year, it is noticeably higher than the 4.9% unemployment rate recorded in January. The unemployment rate has been slowly rising so far this year, a sign of rising excess capacity.
Another sign of increasing excess capacity is the growing number of people in jobs who would work more hours if those hours were available – the underemployment rate. The underemployment rate (percentage of people wanting to work more hours compared with total people employed) rose to 9.0% in August from 8.9% in July and 8.7% in August 2018.
One consequence of the drift upwards in both the unemployment rate and the underemployment rate over the past year is weak wages growth. Wages have been rising but at only between 0.5% and 0.6% each quarter and with most of the impetus in the public sector. Annual wages growth seems to be on a plateau around 2.3% y-o-y, too soft to bolster growth in household income to a point that could promote more confident household spending.
The RBA has made it plain that it wants to see the unemployment rate fall below 5% and it would regard annual wages growth above 3% y-o-y as a positive development. The chances of achieving a sub 5% unemployment rate and 3%+ y-o-y growth in wages seem more remote in the wake of the August labour force report released last week. This is the main reason why we now expect the RBA to cut the cash rate 25bps either in October or November, in time to help make a difference to households’ peak spending heading to Christmas.
Another reason pushing the RBA to cut the cash rate again is that the Government is showing no sign of increasing budget spending beyond what was announced in the pre-election Budget. There were initiatives in the pre-election Budget that will help to boost growth in household disposable income and potentially household spending too. The main initiative was the doubling of the low-and-middle-income tax rebate from $540 to $1,080. The problem is that since that initiative was announced back in April, both global and Australian economic growth prospects have deteriorated and there is now evidence that the Government raised more than it planned in income tax in the 2018-19 financial year, as well as underspending close to $4 billion relative to the 2018-19 budget plan on the National Insurance and Disability Insurance scheme. The net result was that the Government ran an underlying budget position close to balance in 2018-19 rather than the $4.2 billion deficit estimated in the April budget papers.
The Government has nailed its budget colours to the mast of balancing the budget and returning it to surplus. In effect, the Government moves into net saving mode, spending less than its income, and starting to pay down accumulated government debt. That is a laudable objective when there is sufficient growth in spending in the rest of the economy to compensate for Government net saving and enough left over to generate sufficient economic growth to lean the economy towards full-employment. At present, however, there is clearly insufficient economic growth to generate full-employment (consistent with an unemployment rate between 4-4.5%) and the evidence suggests the economy will drift further away from full-employment because of soft growth in private sector spending.
If the Government does not lift spending, there is a strong likelihood that GDP growth stays comparatively soft. GDP growth is likely to be even weaker if the Government runs a tighter budget than planned as it did in 2018-19. If the Government recognises that aiming for budget surplus is a dubious virtue in current economic circumstances and announces more spending initiatives, the pressure on the RBA to cut the cash rate further will ease. At this stage, we see no sign that the Government is moving away from prioritizing the return to a budget surplus. That is why we now see a likelihood that the RBA may need to cut the cash rate another 25bps to 0.50% early in 2020.
Other reasons for the RBA to cut rates include signs that China’s annual GDP growth rate fading into sub-6% y-o-y in the second half of 2019 taking its toll on the strongest part of the Australian economy – exports. A slide in global economic growth prospects and an almost general easing of monetary policy by major central banks overseas also places pressure on the RBA to cut rates preventing unwanted firming of the Australian dollar exchange rate. Weaker global growth prospects mean that the Australian dollar should weaken. The RBA will not want Australian interest rates to stand in the way of delivering a softer currency.
In summary, we are likely to see the RBA cut the cash rate by 25bps to 0.75% either in October or November. We also see the possibility of a further 25bps cut to 0.50% early in 2020.