THE WEEKEND ECONOMIST: Only a matter of time

The Reserve Bank board meets next week on May 7. We expect the board will keep rates on hold while maintaining its clear easing bias. Expect words to the effect of "the inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand".

This decision is likely to be a closely run event since we think the case for another cut has now been made. However, with rates at historical lows, we think the board will be cautious and decide to wait another month before moving. Accordingly we are retaining our forecast that the next move in rates will be a reduction of 25 bps in June to a new historical low of 2.75 per cent.

We have held that forecast for a low of 2.75 per cent since May last year. Our current view is that rates will then be on hold through 2013 and 2014 but we recognise that the risks are clearly to the downside – recent developments have increased those risks.

Markets are currently pricing a 60 per cent probability of a 25 bps cut in May and a 95 per cent probability that the cut of 25 bps will certainly happen by June. There is a 100 per cent probability of a further cut of 25 bps by year's end. Market pricing then points to a long period of rates being on hold with a mild hint of upward pressure through 2014.

There are attractions for the board to decide to move immediately. In particular, it would allow the staff to provide a full explanation for the move in the statement on monetary policy which follows the February, May, August and November board meetings.

This timing, which also follows the quarterly inflation report, has tended to be used more often in tightening cycles than in easing cycles. In this easing cycle to date two moves have followed CPI prints and four have come in "other" months. In the last two tightening cycles 10 moves have followed a CPI print and "only" eight moves have come in other months.

This is likely to be explained by the CPI being more important during tightening cycles while growth is the key influence in easing cycles. That assertion is supported by the wording in the easing bias (see above) where the decision is seen to be dependent on the growth outlook given the low inflation.

The CPI print on April 24 which showed six-month annualised core inflation running at 2 per cent – the bottom of the target range – confirmed that inflation allowed further stimulus although we doubt whether the print would cause the Reserve Bank to lower its inflation forecast for 2013 and 2014 of 2–3 per cent.

Data on the growth environment since the board meeting on April 2 has been disappointing and supportive of a cut:

- A loss of 36,100 jobs and a rise in the unemployment rate from 5.4 per cent to 5.6 per cent.

-  A slowdown in annual credit growth from 3.4 per cent to 3.2 per cent.

-  A 5.1 per cent fall in the Westpac Melbourne Institute Index of Consumer Sentiment

-  Business Conditions in the NAB Business Confidence Survey falling to the lowest level since May 2009.

-  A 5.5 per cent fall in dwelling approvals in March to be up ‘only’ 3.9 per cent for the year, down from 12.7 per cent for the year to February.

-  A 0.5 per cent fall in house prices in April lowering the quarterly increase in house prices from 2.8 per cent to 1.1 per cent.

- A shock slowdown in Chinese growth to 7.7 per cent compared to a consensus expectation of 8 per cent and a weak Chinese PMI

- A 25 bps rate cut by the ECB; QE boost from BOJ; and indications from the Fed that bond buying could be accelerated.

The only really strong report came with retail sales which showed a sharp 1.3 per cent increase in February following an upwardly revised 1.2 per cent rise in January.

That retail report, however, now points to a likely very solid print for GDP and household demand growth in the first quarter with consumer spending being boosted by 1 per cent or more. Further, export/ import prints point to net exports adding around 0.5 percentage points to GDP growth. More of the overall GDP story will be known by the June board meeting since business investment and construction for the March quarter print in late May.

Of course the March quarter capital expenditure report on May 30 will also include the sixth estimate for Capital Expenditure for 2012/13 and the second estimate for 2013/14. We believe it was the better than expected first estimate for capex in 2013/14, printed on February 28, which averted a rate cut in March and this report remains important for the bank.

The next capex report will give an updated print on prospects for mining and non-mining investment – how quickly is mining slowing and what prospects there are for a boost to non-mining investment.

We do not envisage a capex report that will stand in the way of a June cut but anticipate a cautious board awaiting that news before it moves again.

The details of the Commonwealth budget will not directly impact the rate decision. There is no evidence over recent years of the bank awaiting the budget before moving. Rate moves have occurred in May 2002; 2006; 2010 and 2012 while June moves have been restricted to 2002 and 2012 on both occasions following moves in May.

However, indirectly, it appears that ongoing press coverage of the blow out in the deficit is likely to impact confidence. The Westpac-Melbourne Institute index of consumer sentiment survey will be in the field after the federal budget, which will be announced on May 14, and it is likely that confidence will be adversely affected by the media coverage of the widening deficit. Perhaps the Reserve Bank might adopt a sensible strategic approach to use the rate cut to boost confidence in the aftermath of the budget.

Conclusion

The May board meeting is a live event. The case is there for another rate cut. Historical precedent points to May over June. However, very important information on the state of demand will be available before the June meeting. Given that rates are at historical lows we expect that the "hurdle" for a cautious board will be too high for a move next week. We retain our call that the next cut will be in June.

Bill Evans is Westpac’s chief economist.