Govenor Lowe Signals RBA cut to come

Chief Economist's View

Download the PDF version including our economic update by region here: Governor Lowe signals RBA cut to come

Two crucial data points hit Australian financial markets yesterday. One was the news that national employment fell in September for the first time since May, and the second was contained in a speech by Reserve Bank of Australia (RBA) Governor Lowe that conditions were ripe for an easing of monetary policy. Governor Lowe’s speech was given prior to the release of the labour market statistics, and in any case, was prepared in advance, so the fall in September employment did not influence Governor Lowe’s message. Nonetheless, the backslide in the employment numbers eliminates any residual doubt about the RBA’s intentions at its next meeting in November.

So, what did Governor Lowe say to make us so sure of a rate cut to come at the RBA’s next Board meeting? The key for us was Governor Lowe’s comments around the rationales for easing now, and for why the RBA abstained from easing policy further throughout April to October. The last rate cut imposed by the RBA was in March 19, midway between the scheduled March and April monetary policy meetings of the RBA Board. Governor Lowe explained that further rate cuts were deemed to be ineffective while the economy’s supply side remained COVID constrained, and the appropriate policy response was fiscal in the form of the JobKeeper program and JobSeeker supplement.

Now that the economy is reopening, and Victoria is easing restrictions, monetary policy can once more serve to stimulate demand and lean against further appreciation of the currency. The misstep in the labour market recovery only adds to the probability of easing at the next RBA meeting rather than at later meetings. This is particularly the case given Governor Lowe’s consistent messaging that the most important target for policy makers to focus on is job creation. Governor Lowe is concerned that any persistence of high levels of unemployment will be difficult to shake off, and as a consequence, both fiscal and monetary policy support should be applied without delay.

Governor Lowe also raised the prospect of further easing by overseas central banks, particularly given the surge in COVID case rates in Europe and the rise in case rates in the U.S. Easing by overseas central banks can be expected to place upward pressure on the AUD in the absence of a matching move by the RBA. Finally, Governor Lowe also signalled a major change in the RBA’s approach to targeting inflation. Although the prospect of inflation being a problem in the Australian economy is some distance into the future, Governor Lowe nonetheless indicated a switch in the RBA’s approach away from aligning rate hikes with expectations of rising inflation to aligning rate hikes with the actual inflation rate.

Specifically, Governor Lowe indicated that the RBA will not raise the cash rate until the actual inflation rate returned consistently within their target band of 2-3%. In contrast, the approach to date has been to begin raising rates in advance of the actual inflation rate moving within the RBA’s band. The rationale was that given the lags between the raising of interest rates and their impact on the economy, the RBA would have to raise rates in anticipation of rising inflation to avoid falling “behind the curve” with the result that inflation moved beyond the upper bound of their target range. However, the experience of the post-GFC era has been one of continual difficulty of central banks keeping inflation from falling below target levels and, hence, the RBA taking a more conservative approach to hiking the cash rate in a move mimicking the US Federal Reserve.

Finally, it should be pointed out that not all the September labour market data was bad. Clearly, it was Victoria that dragged down the national figure, with the remaining mainland states all recording positive employment growth; albeit at fairly modest rates. We should also be careful in using employment data and the unemployment rate alone in determining the state of the labour market, and hours‑worked data is a useful addition to the two traditional measures of labour market performance.

Here, the news was more upbeat, with hours worked increasing by 0.5% over September as workers on JobKeeper, who have been stood down and therefore have been working zero hours, return to work. Another positive feature of the data was the continued improvement in female employment. Female workers suffered disproportionately over March to May during the national lockdown with around 90,000 more job losses than their male counterparts. The main reason for this underperformance was the over-representation of female workers in some of the hardest hit industries (in absolute terms) of hospitality, education and health. Since May’s low point, the rebound in employment has favoured female workers as employment in these industries recovered, with female employment rising by 276,000 compared to the rise in male employment of 170,000. Over the entire COVID period, male employment is down 222,000 while female employment is down by 206,000.

Table 1: Financial market movements: 8 - 15 October 2020

Source: Bloomberg