Peter Rawson-Harris, Research Analyst, Macquarie
Friday 06 May 2016
Monthly economic commentary: April 2016
Peter Rawson-Harris, Research Analyst, Macquarie
Economic and market highlights
The Australian inflation data was weaker than expected. For the first time since 2008, the headline Consumer Price Index (CPI) was negative, at -0.2 per cent quarter-on-quarter. The critical trimmed mean measure of CPI fell to 1.7 per cent, which is well below the Reserve Bank of Australia’s (RBA) target band of 2 to 3 per cent. This gave the RBA room to cut rates, despite stronger labour force data, to help spur the economic activity via a weaker Australian dollar and the transition from mining to non-mining investment.
Central banks in Europe and Japan have spent a month playing roulette over interest rates. Neither the European Central Bank nor the Bank of Japan moved rates further into negative territory as they wait to see the effects of negative rates filtering through closely watched economic metrics. In the United States, employment and labour force participation numbers remain strong, and measures of manufacturing activity continue to build steadily. Macquarie is forecasting a Federal Funds rate of 0.75 per cent by the end of 2016, with a 25 basis point rate rise in June, and a further 25 basis points in December.
After a 50 basis point fall in US 10-year yields earlier in the year on dovish rhetoric from the Federal Reserve, March and April have seen 10-year yields trading in a tighter range while market participants await further commentary from the Federal Reserve and the release of any economic data which may provide clues as to future monetary policy adjustments. Japanese yields are stuck in negative territory for the time being, while German 10-year rates hit their lowest level since April 2015 at 0.10 per cent.
Much like the US, Australian yields have also spent the past couple of months looking for direction, finally receiving a nudge when the RBA announced a 25 basis point cut to the cash rate. While the RBA has been very consistent and deliberate with their messaging, it tends to provide less detailed forward guidance on future policy than the US Federal Reserve.
Major equities markets generally tread water in April with the exception of peripheral European markets and Australia. The Australian S&P/ASX 200 added 3.3 per cent in a display of relative buoyancy, while in the US, the S&P500 climbed only 0.3 per cent. The EuroStoxx 50 rallied 0.8 per cent, while the FTSE 100 gained 1.1 per cent. The German DAX managed 0.7 per cent. Spain and Italy were higher by 3.5 and 2.7 per cent respectively.
In Asia, the Hang Seng lifted 1.4 per cent while the Shanghai Stock Exchange Composite lost 2.2 per cent. Japanese currency strength saw the Nikkei 225 weaken 0.6 per cent.
The US dollar weakened for the third straight month, with the US dollar index losing a further 1.6 per cent, taking year-to-date losses to 5.8 per cent. The Australian dollar weakened a fraction, shedding 0.8 per cent. The Japanese yen gained 4.8 per cent, much to the chagrin of the Bank of Japan. The Canadian dollar added 3.2 percent, the UK pound sterling rallied 1.9 per cent, and the euro gained a marginal 0.5 per cent.
Finally, the Reserve Bank of Australia cuts interest rates
Only hours before the release of the Federal Budget 2016-17, the Reserve Bank of Australia cut interest rates by 25 basis points to 1.75 per cent at the May Board meeting. Interest rate futures markets were sitting on the proverbial fence in the moments prior to the announcement, pricing in half a rate cut.
In typical RBA style, there was little indication provided as to the future direction of monetary policy. However, this is not surprising given the attention central banks around the world have received when forward guidance was deemed by market participants and commentators to be at odds with policy outcomes, leading to concerns about policy effectiveness.
In the statement by RBA Governor Glenn Stevens, weaker than expected inflation was acknowledged as a key reason for the interest rate cut. Governor Stevens stated that, “while the quarterly data contain some temporary factors, these results, together with ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast”. With the trimmed mean inflation measure for the first quarter of 2016 below the RBA’s 2 to 3 per cent target band at 1.7 per cent, inflation was on a trajectory that would have made it unlikely to regain the target band in 2016.
In addition to comments about the subdued inflation outlook, Governor Stevens also made reference to the housing market and concerns over financial stability, stating that “the potential risks of lower [interest] rates in this area are less than they were a year ago”. As bank lending standards have been tightened and supply-demand dynamics in the housing market have evolved, it became less critical to maintain elevated interest rates to curb risks in a frothy real estate market.
We expect the RBA’s easing cycle to continue with an additional 25 basis point cut in November. The cash rate easing and market expectations of further cuts to come should increase pressure on the Australian dollar, which has not been particularly compliant in the face of dovish communication from the US Federal Reserve. Our forecasts are for the Australian dollar to reach $US0.74 per AUD by June and $US0.69 by the end of 2016.
Instrumental in the future path of monetary policy will be the degree to which the Australian dollar weakens in response to lower rates, and the approaching election.