Two rate cuts before end of the year

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WITH the tax refund failing to stimulate consumer spending, rise in unemployment and the government’s continued political objective of delivering a budget surplus over the health of the economy, could force the Reserve Bank to bring forward two interest rate cuts before the end of 2019.

Capital Economics economist Ben Udy said the economy continues to underperform with the unemployment rate rising to a 12-month high of 5.3% in August.

“The 34,700 rise in employment was driven by part-time employment while full-time employment actually fell by 15,500. That meant that the underutilisation rate rose to 13.8% in August and if this persists the RBA can kiss goodbye to any hope of wage growth picking up meaningfully in the near term.

“The minutes of the RBA’s August meeting reintroduced the line that “the Australian economy could sustain lower rates of unemployment and underemployment” which suggests the RBA may be willing to adjust policy to bring the unemployment rate towards the natural rate.

“The rise in the unemployment and underutilisation rates in August therefore supports our view that the RBA will cut rates again this year. And while we had previously expected the Bank to next cut rates in November, the recent labour market data increases the risk that the Bank cuts as soon as October,” he added.

Udy said either way, with little chance of additional support from the government, Capital Economics reiterates its forecast that the RBA will cut rates to 0.5% by early next year.

AMP Capital chief economist Shane Oliver expects two rate cuts, in October and November.

“Rising unemployment and dovish RBA minutes point to an October rate cut. We were already expecting the next cut to come in October but two developments over the last week have seen the money market move the probability of a cut up from 22% a week ago to 84% now.

“First, the minutes from the last RBA board meeting were more dovish in dropping the requirement for an “accumulation of evidence” before another easing and noting that its liaison program showed that retailers are yet to benefit from the tax cuts and that the uptrend in wages growth looks to have stalled.

“Secondly, and more importantly, while jobs growth in August was strong the quality was poor with falling full time jobs and both unemployment and underemployment rose further which makes it very hard to see a pick-up in wages growth anytime soon. In fact, job vacancies and hiring plans point to slowing jobs growth ahead and hence even higher unemployment.

“All of which will be impossible for the RBA to ignore. As a result, we continue to see the next 0.25% cut coming in October followed by another cut in November, ultimately taking the cash rate down to 0.5%.” Oliver said.

Udy said the weaker economy needs support but the government is prioritising the budget balance over the health of the economy.

“The government revealed that in the 2018/19 fiscal year the budget remained in deficit. The deficit was just $690 million, rounding to 0.0% of GDP, much smaller than the $4.2 billion or 0.2% of GDP deficit that was forecast in the April Budget. Indeed, Treasurer Josh Frydenburg celebrated that the budget was “back in balance’. But that’s of cold comfort to the Australian economy.

“The actual number has limited meaning for the economy. But at least if the balance had been in surplus the government would have had little reason not to deliver additional fiscal stimulus as we have been calling for. However, given that the surplus remains just out of the government’s reach, we think they will continue to prioritise the budget balance over the health of the economy.” Udy said.

Meanwhile for the second time this month, the NAB Economics team has changed its call on monetary policy. Earlier this month chief economist Alan Oster said the government is focused on the political objective of returning a budget surplus and unless it delivers a meaningful fiscal stimulus, the RBA could be forced to cut rates to 0.25% by mid next year.

On Friday, NAB predicts a rate cut in October and December.

“We have brought forward our expectation for each of the next two predicted rate cuts by a meeting; that is, we now expect a 25bp cut in October and December (previously November and February),” Oster said.

“It appears that the impact of income tax cuts has been muted, or at least failed to offset growing weakness in the household sector. Furthermore, we previously anticipated some further support from fiscal policy but now believe this is unlikely in the near term.

“With monetary policy involving longer lags, we think the urgency to lower rates sooner has increased. Longer term, we still think that unless there is meaningful fiscal stimulus the RBA is likely to cut to 0.25% and adopt unconventional policy by mid-2020.” Oster concluded.

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