RBA on hold, but prepared to do more

Emily Nicol

After another positive session in US and European stock markets yesterday, Asian equities made further gains today. Most notably, Japanese markets were in catch up mode following yesterday’s holiday with the TOPIX up 1.7% on the day. But as an FT report suggested that the US was debating whether to reduce tariffs on $112bn of Chinese imports and China’s central bank reduced costs on one-year funds to banks for the first time since 2016 in a bid to ease liquidity concerns, the main CSI300 closed 0.6% higher too.

But as the yen edged back towards ¥109/$, JGBs made significant losses overnight as the BoJ scaled back slightly the amount of 10-25Y bonds purchased under its regular operations – indeed, 10Y yields increased 5bps to -0.14%, while 30Y yields were 4bps higher at 0.37%. This move appeared to be exacerbated by comments from BoJ Governor Kuroda, who offered a relatively optimistic economic assessment that the global economy was past its worse, therefore implying that further policy easing wasn’t imminently on the cards despite emphasising that the BoJ’s latest policy guidance was tilted that way. While European govvies have also opened lower, the latest UK services and composite PMIs due this morning seem likely to signal ongoing weak economic conditions at the start of Q4. And the US non-manufacturing ISM will be also closely watched for further signs of slowing, having fallen to a near-three-year low in September.

There were no surprises from the conclusion of the RBA’s latest monetary policy meeting today, with the cash rate unchanged at a record low 0.75%. But the accompanying statement by Governor Lowe still offered a dovish stance, reiterating that “it is reasonable to expect that an extended period of low interest rates will be required in Australia” and that the Board is “prepared” to ease monetary policy further if needed. As far as we’re concerned, it seems far more likely than not that, in due course, it will have to put those preparations into action.

Certainly, the statement again flagged that the downside skew to risks to the outlook for the global economy, with the China trade and technology disputes continuing to affect trade flows and global investment. In terms of domestic developments, the RBA assessed that the outlook was little changed from three months ago, although it once again maintained cautious optimism that “a gentle turning-point appears to have been reached”. This notwithstanding, the RBA still assessed that the outlook for consumption was uncertain, with only household disposable income growth continuing to weigh on consumer spending. The RBA also added that the effects of the drought and housing construction cycle offered additional sources of uncertainty. As such, the RBA nudged down slightly its GDP forecast this year to 2¼%Y/Y (from 2½%Y/Y previously) with growth then expected to gradually pickup to around 3% in 2021.

While inflation broadly aligned with the Bank’s expectations in Q3, the RBA continue to see only a gradual pickup in inflation over the forecast horizon, not least given spare capacity in the labour market and economy as a whole. And with the unemployment rate forecast to remain above the Bank’s estimation of the NAIRU and therefore wage growth set to remain subdued, the RBA saw both headline and underlying inflation to be “close to” 2% in 2020 and 2021, barely consistent with the 2-3% inflation target range. We will have the full set of economic forecasts in the Bank’s quarterly Monetary Policy Statement on Thursday.

While market pricing currently suggests that no further rate cuts are expected over the coming year, we continue to think that it seems far more likely than not that, in due course, the RBA will to put those ‘preparations’ into action. And with 0.50% the likely floor in the cash rate, unconventional policy measures (QE) seems likely to be on the cards too, perhaps most likely when China’s economy has slowed significantly further.

The UK’s October PMI surveys will conclude today with the services and composite indices. Having slipped below the key 50 expansion level in September, the headline services activity PMI is expected to have moved broadly sideways at 49.5. Admittedly, given the modest upside surprises to the equivalent manufacturing and construction PMIs, risks to this forecast seem skewed to the upside. Nevertheless, with the manufacturing and construction indices still firmly in contractionary territory, the all-sector PMI might well remain below 50 for the second successive month and only the third time since 2012.

There was at least a modest improvement in conditions for retailers at the start of the fourth quarter according to the BRC retail sales monitor, which showed that on the back of heavy discounting in October sales were up 0.6%Y/Y, the strongest annual pace since April. But this followed a decline of 1.3%Y/Y previously, while like-for-like sales were much softer at just 0.1%Y/Y. So when smoothing out monthly volatility, underlying sales growth still remained weaker, with total sales down 0.3%3M/Y and like-for-like sales down 0.8%3M/Y. And in the absence of ongoing solid growth in food sales, the decline would have been weaker – indeed, in terms of total and same store, sales of non-food items were almost 2%3M/Y lower, suggesting that underlying domestic demand remains subdued. And with consumer confidence still weak, Brexit unresolved and December’s General Election an additional uncertainty, we would expect consumer spending to remain relatively restrained over coming months too.

Later this morning will also bring the latest car registration figures for October, while in the markets, the DMO will sell 10Y Gilts.

Euro area:
It should be a quieter day for euro area economic news, with just PPI data for September due for release. In the markets, Germany will sell index-linked Bunds.

In the US, this afternoon will bring a number of top-tier releases including October’s non-manufacturing ISM and final Markit services and composite PMIs, as well as the full trade report for September and JOLTS job openings figures for the same month. In terms of Fed Speak, Kaplan, Barkin and Kashkari are all in action, while in the markets the Treasury will sell 3Y Notes.

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