Reserve Bank board members may well have thought Tuesday’s meeting would be pretty simple, right up to the point when the inflation figures dropped last week.
Headline inflation was tricky enough — down 0.2 per cent, the first fall in seven years.
But the breadth of the weakness and the steep decline in the RBA’s preferred measure, core inflation, turned an almost certain “hold” into a 50:50 proposition.
The current betting, framed by the ASX 30 Day Interbank Cash Rate Futures, showed a dramatic shortening for a cut to 1.75 per cent at almost 60 per cent at the close of business on Friday night.
Bloomberg’s survey of leading market economists found 10 of 24 thought a cut was likely.
The current board has shown a reluctance to cut in the past and governor Glenn Stevens constantly reminds anyone listening that the inflation band of 2 to 3 per cent has a degree of flexibility being “on average, over the course of the cycle”.
Economic growth does not argue for a cut, employment is strong and China has the appearance of regaining its mojo, which has translated in higher iron ore prices.
Those pushing for a cut are not exactly passionate about it, with the feeling being a cut now could nip any deflationary shoot in the bud.
Core inflation was at the its weakest point in 16 years, well below the bottom of the RBA target, and the argument is that it is now unlikely to get back to 2 per cent until next year at the earliest.
The pro-cut brigade sees this as crossing the line from a temporary dip to a more entrenched issue.
The National Australia Bank (NAB) noted: “The RBA remains an inflation-targeting central bank, so faced with this new lower inflation forecast it now seems likely it will vote in May to take the opportunity to provide some slight further assistance to the Australian economy and so potentially help lower the unemployment rate more quickly than previously forecast.”
May meeting one of four likely to alter policy: Baader
The May meeting is one of four per year where the board has the benefit of new economic forecasts which make up the quarterly Statement on Monetary Policy (SoMP), which is released to the public on Friday.
Societe Generale’s Klaus Baader makes the point that it appears the greater-than-normal amount of new information at the May, August, November and February meetings makes a decision to alter policy more likely than at the other meetings.
For the statistically minded, in the past ten years the RBA has changed its policy rate five times at a May meeting, meaning there is historically a 50 per cent chance of a rate change in May.
“That is considerably higher than the probability of a rate change at any monthly meeting, which is 27 per cent — 30 changes in 110 meetings,” Mr Baader noted.
On Mr Baader’s reckoning the SoMP will revise growth up for 2016, but lower it for the end of the year, with longer term trends unchanged — forecasting GDP growth at 2.5 to 3.5 per cent, which certainly does not put it in cutting territory.
On inflation, the mid-2016 forecast for headline inflation was 1.5 per cent in February, but will now likely drop to 1 per cent, while the core forecast, which was 2 per cent, will probably end up at 1.5 per cent.
“However, we do not believe this will be a trigger for a rate cut … the policy-relevant horizon has moved to at least 2017, and we expect the 2 to 3 per cent range to be maintained,” Mr Baader said.
Other local data next week will include the always volatile building approvals — on Tuesday — which are expected to unwind the gain from the month before, the trade balance — on Thursday — which is set to be another $3 billion-plus monthly deficit and retail sales — on Friday — which look soft, particularly so as inflation is retreating and prices falling.
What to watch for in the federal budget
If the RBA board has a delicate balancing act, spare a thought for the main act in Tuesday’s economic circus, Treasurer Scott Morrison.
He has to juggle a pre-election budget with vote-winning goodies, without jacking up taxes and keeping the spending chainsaw running to put the budget back on track to a credible and sustainable surplus.
The recent bounce in iron ore prices might kick in an additional $3 billion this year and $10 billion into 2017, but it may not be enough to prevent the deficit expanding from the last Mid-Year Economic and Fiscal Outlook (MYEFO) estimate and a return to surplus slipping further into the future.
The spotlight will be on revenue measures relating to superannuation, tax cuts for larger corporations, a crack down on tax minimisation by multinationals and the removal of bulk billing incentives for pathologists.
On the spending side, expect a generous splurge on big-ticket infrastructure projects and road building.
Looming bank results have investors fretting
On the local equity market, investors large and small will be fretting about the mini-reporting season in the banking sector, with Westpac, ANZ and NAB trotting out interim results and Macquarie Group’s full-year numbers.
The banks face a number of challenges including the likelihood of rising bad debts through exposure to some high profile corporate lending gone bad and the odour built up around some pretty dodgy practices.
Macquarie analysts issued an interesting research note last week finding “short” positions in the banks are currently at their highest levels since 2011.
Macquarie found the bulk of the shorting and selling was carried out by offshore investors, while domestic institutional and retail investors were net buyers.
“Broader macroeconomic and regulatory concerns coupled with rising impairment charges have resulted in a 10 per cent decline in bank share-prices and 50 per cent rise in short positions since the beginning of this year,” Macquarie told clients.
ANZ and Westpac have the highest level of shorting in among the majors, while Bendigo and Adelaide Bank has the highest overall.
“Should the upcoming results and outlook commentary exceed current relatively bearish expectations, bank share-prices could rebound,” Macquarie argued.
Forecast to produce a $4.1 billion first half profit on Bloomberg’s consensus data, up from last year’s $3.6 billion effort.
It has already owned up to some ugly exposures and its bad debt ratio will tick up. It has been cutting costs and closing branches, so cost performance should be a key figure.
On APRA figures Westpac has been growing both lending and deposits above the sector’s average, so it will be interesting to see exactly where the strength lies.
Westpac is probably in a position to nudge up its dividend, which would go down well with yield hungry investors.
First half cash earnings are tipped to be flattish at around $3.6 billion.
It too has already hung out its bad loan laundry, so adding more would not be a great look.
ANZ’s margins are expected to improve on earlier flat guidance as the impact on “mortgage repricing” — in other words making home loans more expensive — flow through.
ANZ is seen as the lender with the most pressure on its dividends but it probably will not cut.
A key piece of commentary from new chief executive Shayne Elliott will be his vision for the Super Regional strategy embarked upon by his predecessor, Mike Smith.
A flat first half profit of $3.4 billion is forecast.
NAB’s bad-debt-to-total-loan ratio is the lowest of the big four, so it will be interesting to see if it can maintain that quality and resilience.
APRA data suggests its turning around its business lending, so focus will centre on margins there. Its capital position is solid, but may need a top up thr
ough an expanded dividend reinvestment program.
NAB is also above its payout ratio, but should still maintain its dividend.
Macquarie Group (Friday):
Full-year profit is expected to climb just above $2 billion, a handy 25 per cent jump on last year.
The recent third quarter update was solid, with only its commodities and financial markets division weaker.
As an investment bank commentary on market volatility should be interesting, and the dividends are forecast to rise as well.
US unemployment may tick below 5 per cent
Globally the most significant data pops out at the end of the week with US non-farm payrolls out on Friday.
With a drop in jobless claims reported last week, the number of new jobs created is forecast to again exceed 200,000, while unemployment may tick down to 4.9 per cent.