The suspension of the US debt ceiling deadline until mid-January allows financial markets to focus on other influences on asset prices for a few months. One of the more important of those influences is that notwithstanding the lumps and bumps in the US economic numbers in the wake of the partial government shutdown, global economic growth is slowly picking up momentum. Equally importantly, several of the world’s major central banks are pursuing very accommodating monetary policy for the forseeable future and arguably the US Federal Reserve (Fed) has rejoined this group. The Washington standoff is likely to have dented US growth in the near-term pushing out by several policy meetings the start of the Fed’s reduction in its monthly asset purchases, or QE. All told, the outlook for risk assets such as equities and credit seems to have improved and that includes the outlook for Australian risk assets too in our view.
In Australia, markets can focus more squarely on local economic prospects. Rather like the international economic outlook a slow improvement in growth seems likely with strengthening housing activity and slightly faster growth in retail spending more than offsetting the pullback in mining investment (which in any case is showing signs of not being quite as severe as feared a month or two back). Inflation is very well contained too, providing perhaps some capacity for the RBA to lower its already very low 2.50% cash rate. Our view on further RBA cash rate cuts however is that they are possible, but increasingly unlikely.
We do not dispute that inflation is very low. The Q3 CPI report is due on Wednesday and our forecast is that the headline CPI will rise by 0.6% over the quarter, a smaller increase than the market consensus forecast of 0.8%. On our forecast the annual inflation rate falls to 1.6% y-o-y and on the consensus forecast to 1.8%, either well down from 2.4% y-o-y in Q2 and below the bottom of the RBA’s 2-3% target range. The relatively low forecast Q3 headline CPI is also expected to be evident in underlying inflation too with the two measures favoured by the RBA (the trimmed mean and weighted median) each expected to rise by 0.6% q-o-q with annual readings of respectively 2.1% y-o-y and 2.3%.
Low inflation provides the option for the RBA to cut rates further and factors such as the resurgence of the Australian dollar to close to USD0.97 (the RBA would prefer nearer to USD0.85 to help rebalance the economy) provide some reason to cut. The argument against cutting further, however, is also very powerful. Home buying activity and house prices have been rising very strongly for several months and the impact of earlier cash rate increases are still feeding through. Adding more fuel to the home buying fire increases the temptation for mortgage providers to loosen their lending standards and chase share of a rapidly growing home loan market. On the other side of home loan market, households have improved their balance sheets over the last few years providing a useful buffer against future financial shocks. That buffer could evaporate fast if rapid growth in demand for home loans becomes a stampede.
The RBA in the minutes of the October 1st policy meeting used the word “prudent” describing why it was leaving the cash rate unchanged. Our view is that the RBA is now on solid policy hold. Low inflation and the stronger Australian dollar point to a case for further rate cuts, but that case is trumped by concern that lenders and borrowers may be close to throwing caution to the wind chasing the housing market. The good news is that the RBA is still in a position to hold the 2.50% cash rate for many months to come. Low inflation means no pressing need for the RBA to start lifting the cash rate.