The surprise policy move by the RBA last week, cutting the cash rate by 25bp to a record low 2.75% is unusual in that it represents a further easing of an already very accommodating policy setting at a time when there is ample evidence that growth in household spending has been accelerating since the beginning of 2013. The RBA explains this unusual policy easing and the possibility of further easing over coming months as appropriate given two factors – persistently low inflation and a detraction from growth over the next year because of the topping out of the resource investment spending boom.
Interestingly, the RBA admits in its quarterly assessment of the economy that there is uncertainty about the outlook for inflation and prospects for investment in the resource sector. The RBA forecasts inflation staying inside 2-3% target band over the next two years with high non-tradables inflation (4.2% y-o-y in Q1) fading helped by improving labour productivity and contained wages growth and tradables deflation remaining an offset.
One problem that is already starting to show, challenging the RBA’s inflation forecasts, is that the labour market, rather than being a little softer, as the RBA forecasts appears to be resilient according to the labour force readings over the past three months. In April, employment rose by 50,100 after a revised decrease of 31,200 in March and a 71,700 increase in February, an average 30,200 monthly increase over the three month period. The unemployment rate is starting to drift lower too, down to 5.5% in April from 5.6% in March. A drift up in the unemployment rate over the next few months would be more consistent with the RBA’s inflation forecasts, but that is starting to look unlikely.
More importantly, the RBA’s forecasts appear to downplay clear evidence of a strong improvement in home buying activity, evident since late February in high weekend auction clearance rates and a turn to much stronger retail spending activity (while retail sales fell by 0.4% in March, they rose particularly strongly in in January and February and were up 2.2% in volume terms in Q1, the strongest quarterly increase in six years).
We now see strongly improving household spending through the remainder of 2013. We cannot rule out another cash rate cut to 2.50% as the RBA has just about said that they have room to cut further. However, we see 2014 as a pay- back year where the cash rate may need to rise back to 4.00% by the end of the year. In the near term (the next 3-6 months) the combination of easier monetary policy and rising domestic spending is likely to continue the current highly favourable environment for risk assets, including credit.