BOAML: Australia's 'glacial' economic rebalancing not enough to see the RBA cut rates further

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Even if this week’s Australian March quarter business capital expenditure forecasts come in softer than what markets currently expect, it will probably not be enough to see the RBA lower interest rates any further.

That’s the view offered by Alex Joiner from the Bank of America-Merrill Lynch (BOAML) over the weekend. He stipulates that a prolonged period of sub-trend growth “will have to be tolerated
as the rebalancing of growth unfolds at a glacial pace”.

Here’s Joiner:

The expected lack of rebalancing in growth has been one of the most noticeable aspects of recent official forecasts. In both the RBA’s Statement on Monetary Policy and in the federal budget the outlook for business investment over the coming year(s) was downgraded. This is as both the timing and strength of the expected rebalancing in investment has continually disappointed. Indeed, since the resources cycle peaked as a percentage of GDP in December 2012, it has so far declined 1.8% of GDP. However, over the same period, non-resources business investment has also declined 1.1% of GDP. Similarly, public sector investment has fallen 0.4% of GDP. Forward indicators suggest circumstances do not appear as if they will materially improve.

While some in the market believe that another weak capex intentions survey will add to the case for the RBA to reduce interest rates further, as was the case following the release of December quarter survey in late February, Joiner believes continued weakness will not be enough to see the RBA cut rates further.

“We assert that monetary policy in Australia already has breached the lower bound of effectiveness in terms of any direct stimulatory impact on non-mining investment in the economy. The RBA asserted long ago that it is not the level of borrowing rates that is impeding future investment decisions. However, the bank now does suggest that lower rates still will be effective, as they will stimulate activity in the household sector. This in turn will provide the better conditions that will lead businesses to invest.

We expect that if successful, this course will be a long, drawn-out process, which explains the RBA pushing back its forecasts for recovery. The risk here is that consumers do not materially increase their spending, neither from lower mortgage payments nor increased borrowing for consumption. Rather, it is reliant on soft income growth, which therefore will remain subdued. If cutting the cash rate 225bp in the 2011-2013 leg of this easing cycle has produced still below average rates of household spending, then another 50bp is unlikely to produce a materially different result, in our view”.

One of the preconditions Joiner places on his call is that the Australian dollar will fall to US73c by year end and US68c in 2016. This is substantially lower than those estimates offered by the RBA which sees the currency remaining around US80c between now and the end of the 2016/17 financial year.

The outlook for US interest rates will largely determine whose forecast is most correct.

Australian Q1 2015 Private New Capital Expenditure and Expected Expenditure will be released on Thursday.

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