Weekend Economist: Stevens' swipe

Glenn Stevens had nothing to lose talking down the dollar. But we'd need to see a major consumer downturn for another rate cut.

As expected, the board of the Reserve Bank decided to leave the cash rate unchanged at 2.50 per cent after its meeting on July 1. The governor’s statement that accompanied the July decision is almost identical to the statement which he released following the June Board meeting.

The major change in markets since the June board meeting has been the further lift in the Australian dollar from around 92.5US¢ at the time of the June meeting to 94.5US¢ on the day of the meeting. As a result markets were interested as to whether the bank might have strengthened its language around the exchange rate. In the event the language was changed but was not significantly different. To have credibly supported much stronger language, such as reintroducing the “uncomfortably high” commentary that was used in the last months of 2013, the RBA would need to back that commentary up with the reintroduction of an easing bias.

In a subsequent speech the governor strengthened his commentary around the Australian dollar referring to it as "overvalued, and not just by a few cents". He did not go as far as restoring the easing bias but did quote market pricing as indicating that " if a move were to occur over the next several months ... it would be down not up". He also noted that "we still have ammunition on interest rates". Market pricing is now pointing to a 40 per cent probability of a rate cut by year's end. Quoting market pricing is significant. It is my experience that the RBA quotes market pricing when it supports its message.

That speech was delivered before the May retail sales data was released. That report showed that retail sales contracted in May by 0.5 per cent following a 0.1 per cent dip in April and a flat March print. Overall sales fell by 0.5 per cent over the 3 months. That represents a very sharp slowdown in retail sales, which, if sustained will most likely ensure a considerable drag on demand and a likely slowdown in jobs growth as businesses link employment decisions to demand.

Complicating factors for retail were unseasonally warm weather which affected clothing (down by 2.3 per cent); department stores (down 2.6 per cent) and household goods (down 0.9 per cent). In addition we expect that trepidation around the budget in March and April followed by a negative response in May constrained consumer spending.

The future profile of the consumer along with housing will determine whether the governor delivers on his implied musing about lower rates. In that regard we are reasonably optimistic that the consumer and housing will "bounce back".

A further slowdown in housing would allow the bank some flexibility to deal with the growth and inflation implications of a major deterioration in consumer spending.

We expect that the negative impact of the budget on confidence and spending will ease as we move through 2014. Strong fundamentals around a high savings rate and a large wealth effect ($700 billion lift in 2013) are likely to underpin a lift in the consumer in the second half of 2014. Further, there is considerable opposition to some of the more unpopular budget initiatives in the new Senate, potentially indicating some compromise.

The momentum in housing has eased in recent months. We note that momentum in house prices has only been significantly arrested in previous cycles with a rate hike. With rates on hold (from our perspective) until late in 2015 there appears to be scope for at least maintaining current momentum in housing.

Note that the market has already received a "rate cut" in 2014 with some banks reported to have increased discounting on new loans in recent months.

We also noted some lift in sentiment toward housing in the June consumer sentiment survey. "Whether now is a good time to buy a house" lifted by 11 per cent in the June survey after falling 34 per cent over the previous 8 months. That index has had a reliable lead over house prices of around 6 months and correctly predicted the slowdown in house price momentum.

The bank will be patient over the rest of 2014. It would only cut rates if the Australian dollar remains around current levels and the consumer and housing slow sharply - eventually causing the bank to lower its growth forecasts for 2015. It is too early for that decision at the August statement on monetary policy. Maintenance of these very low rates is likely to see a "recovery" in the momentum in consumer spending and, at least, a maintenance of housing momentum. Such a profile would preclude the possibility of lower rates.

Bill Evans is chief economist with Westpac.