RBA Governor signals reluctance to ease further

Emily Nicol
Chris Scicluna

Overview:
While the confirmed coronavirus death toll has approached 500, the number of confirmed cases is close to 25k, and uncertainty prevails over the true scale of the epidemic, investors yesterday clearly judged that the impact will be contained and short-lived. So, Wall Street rallied further (the S&P500 closed up 1.5%), and Asian markets picked up the baton today. Indeed, China’s CSI300 continued to make inroads into Monday’s loss, rising a touch above 1%, with Japan’s TOPIX doing likewise despite a more downbeat final services PMI survey. And while European stocks initially opened lower, the investor mood has been given a further boost by reports from Chinese TV that a university research team has found an effective drug with which to treat the virus.

Indeed, in response to that report, yields on USTs have leapt (10Y yields up more than 6bps in the past hour to above 1.63%). That followed a day of steepening in the JGB curve (10Y yields up 1bp to -0.04%, with super-long yields up close to 3bps). And ACGBs made significant losses (10Y yields up more than 10bps to above 1.02%) as RBA Governor signalled significant reluctance to ease Australian monetary policy further (see below). Needless to say, euro govvies have followed USTs lower this morning, despite some poor Spanish PMIs.

Australia:
In his latest speech in Sydney earlier today, RBA Governor Lowe added to expectations that the bank is now on hold for a lengthy period. Among other things, he noted that recent inflation and unemployment data were in line with the RBA’s expectations and “show things moving in the right direction, although only very gradually”. He also stated that, while the RBA Board had “continued to discuss the merits of further monetary stimulus”, it had concluded that the cost-benefit analysis of such action just didn’t stack up. In particular, he noted increased concerns about the impact that further rate cuts might have resource allocation and confidence of certain people. And he also flagged worries that additional cuts might exacerbate the current strong upswing in house prices, which “could increase the risk of problems down the track”.

The implication of Lowe’s speech – and his subsequent Q&A – was that, at the current juncture, fiscal policy and not monetary policy should do more to boost growth and wages, and thus help inflation return to target. But he also warned that “If the unemployment rate were to be trending in the wrong direction and there was no further progress being made towards the inflation target … the Board would see a stronger case for further monetary easing.” And despite Lowe’s cautious optimism today, there remains a significant chance that will be the narrative at least sometime this year, particularly if fiscal policy doesn’t step up to the plate. Indeed, the markets are still pricing the likelihood of an RBA rate cut in the second half of the year.

Ahead of the release on Friday of the RBA’s detailed economic forecasts in its latest Statement on Monetary Policy, however, Lowe judged that the central growth projection of 2¾% this year and 3% in 2021 was a touch above Australia’s growth potential and hence would maintain gradual progress in pushing inflation closer to target. Among other things, of course, he acknowledged that the coronavirus posed a downside risk to the outlook. But, based on the experience with SARS, he judged the likely impact to be short-lived. And while he acknowledged that the bushfires will also have cut Australian economic growth in Q4 and are weighing on activity in the current quarter, overall he thought that GDP would be only 0.2ppt lower across the two quarters than it otherwise would have been. Moreover, noting that reconstruction, government grants and insurance pay-outs will support growth over coming quarters, he judged that the overall impact on Australian growth over 2020 as a whole will be minimal. He did, however, judge that the ongoing impact of the drought on agriculture would shave ¼ppt off growth this year.

Japan:
Like the equivalent manufacturing survey published at the start of the week, today’s final Japanese services PMIs brought a notable downwards revision. In particular, the headline business activity index was revised lower by more than 1pt to 51.0, nevertheless still 1.6pts above December’s reading and the highest for four months. But despite a pickup in new orders at the start of the year – the survey indicated the strongest increase since June – firms were once again more downbeat about the expectations for the year ahead, with the relevant index falling to its lowest for 29 months, possibly reflecting increased concerns about a potential post-Olympic lull in demand. But the likely near-term impact on Japan’s tourism sector in the face of the coronavirus seems likely weigh on sentiment in the sector over coming months too.

Overall, taken with a still contracting manufacturing sector – the manufacturing output PMI stood at 48.2 in January – despite a notable increase in January (up 1.5pts) Japan’s headline composite PMI was merely consistent with stagnation at the start of the year. Certainly, the impact on Japan’s manufacturers and services alike through various channels – including a possible hit to goods exports, supply-chain disruption and tourism – looks set to dent the post-tax hike economic recovery for a while to come.

China:
For what it’s worth given that the survey was conducted (13-22 January) well before the coronavirus outbreak gained much greater prominence, today’s Chinese Caixin services PMI was already indicating signs of a slowing services sector at the start of the year. For example, the headline business activity index fell for the second successive month to 51.8, a three-month low. But while expectations about future activity rose to the highest since September 2018, this seems bound to fall back this month. And with the composite PMI having fallen to a five-month low of 51.9, today’s survey was consistent with a relatively subdued start to 2020 for China’s economic growth even before concerns about the coronavirus had escalated. Of course, weaker PMIs for January should have been expected given the Lunar New Year.

Euro area:
The main release in the euro area today will be December retail sales figures, which seem bound to post a substantive decline due to the steep drop reported last Friday in Germany. And that could leave overall sales down in Q4 for the first quarter since Q415. Meanwhile, this morning will also see the release of final January services and composite PMIs. The flash services PMI fell back at the start of the year, with the headline index down 0.6pt to 52.2. So, while the improvement in Monday’s manufacturing index might imply a modest pickup in the composite PMI in January, it will likely remain consistent with no material improvement in overall growth at the start of the year.

While Germany’s services PMI is likely to confirm a notable improvement in January (the flash estimate was 1.3pts higher at 54.2, a five-month high), the final French services PMI was particularly disappointing, being revised down a further 0.7pt from the flash to be down 1.4pt on the month to a nine-month low of 51.0. And like the disappointing showing in the Commission’s survey, this morning’s Spanish services PMI also indicated a notable deterioration in conditions at the start of the year. In particular, the headline index fell 2.6pts to 52.3, the lowest for more than six years, while new orders rose at the softest pace since September 2013, as political uncertainties reportedly weighed on demand and sentiment. So despite a notable improvement in the manufacturing output PMI (up 3.1pts to 48.5), the composite PMI declined 1.2pts in January to 51.5, consistent with moderate expansion but nevertheless one of the softest paces of increase since the euro crisis.

Beyond the data, ECB President Lagarde and Chief Economist Lane are due to speak at events in Paris and Berlin respectively later today.

UK:
Like with Monday’s manufacturing survey, today’s revised services PMI is likely to confirm the marked improvement seen in the flash estimate – the headline index increased 2.9pts to a sixteen-month high of 52.9. And so, given the upwards revision to the manufacturing survey, the final composite PMI might also be nudged higher from the preliminary reading, which itself was 3.1pts above December’s reading at 52.4, its highest since September 2018. This morning will also bring new car registrations figures for January, which might also report a second successive month of positive growth as near-term uncertainties have receded somewhat.

US:
A busier day for US releases brings perhaps most notably the non-manufacturing ISM and final services PMI for January, both of which are expected to remain comfortably in expansionary territory. Final trade figures for December are also due. 

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