The Reserve Bank formally lowered its 2009 growth forecast in the May 2009 Statement on Monetary Policy from 0.5 per cent in its February Statement, to -1 per cent in today's Statement. For 2010, it also lowered the forecast from 2.5 per cent to 2 per cent.
Our estimates of the implied quarterly growth profile which the Bank is now adopting have: March quarter -0.5 per cent; June quarter -0.35 per cent; September quarter -0.4 per cent; December quarter 0.2 per cent. Growth in the first half of 2010 is estimated at 0.6 per cent.
In the previous forecasts, growth was implied to be estimated at 0.1 per cent per quarter in the March quarter to September quarters; 0.2 per cent in the December quarter; and 0.9 per cent over the first half of 2010.
So, the Bank would now be expecting both the June and September quarters to be negative compared to negligible growth in their February forecasts. For us, the question is: Given that there is still some available flexibility on monetary policy, do they expect to weather three consecutive negative quarters without taking some further insurance?
Certainly if the strength of the recovery was considered to be excessive in the first half of 2010, then the Bank would be reluctant to cut rates, even if it was experiencing negative growth through the remainder of 2009. However, the strength of the recovery which the Bank is implying in its forecasts is very tepid, and would definitely not preclude rate cuts if there is further slippage in the June and September quarters.
Our assessment of that profile is that the Bank would certainly see a decent case for further cutting rates if this string of negative quarters does occur through 2009. With such a modest pace of 'recovery' the risk of over-stimulus seems slight. It appears to us that the Bank's forecasts are entirely consistent with further rate cuts, and any assessment by the Bank that the risks to this profile have moved to the downside would see a fairly quick response.
However, the tone of this Statement indicates that at least for the next couple of months the Bank is likely to remain on hold to assess whether the current fairly gloomy growth profile might in fact turn out to be a bit better. Our view of the growth outlook is similar to the Bank's assessment, so we expect that when the data confirms this continuing contraction, particularly in the labour markets and business investment, there will be scope for the Bank to continue to cut.
Despite this substantial revision to the growth forecast, the tone of the Statement was reasonably positive. Certainly the risks associated with the global economy continue to be highlighted, but the key observation appears to be: "There are reasonable grounds to expect that a recovery [in the Australian economy] will begin by the end of the year, provided global conditions continue to stabilise. The recovery, however, is likely to be gradual at first, largely reflecting developments abroad, where growth is forecast to be below trend for some time."
In discussing the risks to this outlook, the Bank highlighted two major risks to the downside. Firstly, the Bank noted bad news emerging about the European and US financial systems, which would cause a further increase in risk aversion. The Bank noted that scope for policy makers to continue to address further weakness would be constrained by large fiscal deficits and zero interest rates. The second risk was if the recent signs of recovery in China were not durable.
On the upside, there was some possibility that firms would respond more positively to recent signs of stabilisation by upscaling investment plans – unlikely in our view.
The tone of the Statement was tentatively positive. Key phrases include: "Signs that activity in housing will pick up in the second half"; "recent indicators of business confidence suggest some improvement"; and "consumer confidence remains substantially higher in Australia than in many other countries". But the Bank does note that "household wealth has seen a major decline" and "households have become more concerned about the prospect of unemployment".
The substantial weakness which we have seen in the forward indicators of jobs growth is played down somewhat, with "a further decline in employment over the months ahead" – that could easily have been worded much more strongly given the excessive weakness in these indicators. We would note that the labour market charts in the Statement include yesterday's April upside surprise in employment.
So from our perspective, we were encouraged by the profile of the revised forecasts. However, we were somewhat discouraged by the moderately confident tone of the words. The one set of words however that gave us encouragement that, contrary to market pricing, the Bank will be cutting rates further was the final paragraph, which clearly stated: "In assessing whether further reductions are appropriate over the period ahead, the Board will continue to monitor the implications of both economic and financial developments for prospects of a sustainable recovery in the Australian economy."
That contrasted with the last Statement which did not specifically refer to "further reductions" and in our view indicates that the issue of cutting rates will dominate the agenda of every Board meeting for some time.
Bill Evans is chief economist at Westpac Banking Corporation.