RBA's Lowe hints at more easing as unemployment rises

Chris Scicluna

Most of Asia follows Wall St lower but RBA boosts Aussie stocks
Wall Street fell for a second day on Wednesday, with the S&P500 closing down 0.7%. Bank stocks were again weak, with Wells Fargo’s stock falling 6% following the release of its quarterly earnings report in which it warned that net interest income could decline further next year. Consumer discretionary stocks were also singled out for attention after Treasury Secretary Mnuchin admitted that getting a fiscal stimulus agreement “before the election and executing on that would be difficult”. And US equity futures have traded down a further 0.3% since Wall Street closed. Given that background, most bourses across the Asia-Pacific region weakened somewhat today. The Topix declined 0.7% while losses in that ballpark or above have also been seen in Hong Kong, Taiwan, South Korea, Singapore and Thailand – the latter also not helped by the Government declaring a state of emergency in Bangkok to restrict gathering numbers following further protests directed at the monarchy.

One clear exception to the trend was Australia, where the ASX200 increased 0.5% after the Aussie dollar and bond yields moved sharply lower – the 10Y yield eventually falling 7bps after being down as much as 10bps at one stage. All of those moves followed dovish remarks made in a speech by RBA Governor Lowe, which reinforced the likelihood of further policy easing – perhaps including the purchase of bonds beyond the 3-year maturity that is the RBA’s current focus (plenty more on the speech below).

The other exception was China, where equity markets inched higher as investors perhaps took some comfort from the very strong money and credit growth data published late yesterday, together with today’s soft inflation readings (see below for more on these too) which perhaps leave scope for additional policy stimulus. Helpfully, while leaving its 1-year medium-term lending rate at 2.95%, today the PBoC offered a greater-than-expected CNY500bn to banks, making good on its commitment to keep market liquidity ‘ample’.

Moving to Europe, the market mood today will be clouded by the darkening coronavirus situation, with French President Macron yesterday evening having announced night-time curfews for Paris and eight other cities, German Chancellor Merkel tightening rules in the hospitality sector in several regions, and new restrictions coming to several UK cities, probably including London. The latest EU Summit should, however, pass smoothly without triggering a crisis in the EU-UK negotiations over the post-transition Brexit negotiations.

Japan’s services activity strengthens less than expected in August
Following on from yesterday’s disappointing downward revision to industrial production – albeit leaving it up 1.0%M/M – today METI released news regarding activity in the services sector. And at face value the 0.8%M/M lift in the Tertiary Industry Activity Index during August also appeared disappointing, falling short of market expectations that were centred on a 1.5%M/M gain. However, that disappointment was largely mitigated by revision to activity in July, which is now estimated to have increased up 0.1%M/M – a 0.6ppt improvement on the surprise 0.5%M/M decline that had been reported a month ago. This left the adjusted index down 8.0%Y/Y in August, compared with the revised 8.8%Y/Y decline registered previously and a little less than half the trough decline of -17.4%Y/Y in May. Assuming that activity has increased a little further in September, as suggested by a variety of sentiment indicators, the level of service sector activity will have increased just over 5%Q/Q in Q3. Of course, sadly, this follows the 10%Q/Q slump that occurred in Q2.

In the detail, in seasonally-adjusted terms, personal services activity rebounded 1.5%M/M in August but was still down 8.7%Y/Y. Growth was led by a strong 12%M/M rebound in activity in the utility sector and an even stronger 14.6%M/M increase in activity in the real estate sector, where activity is now up over 12%Y/Y after being down as must as 30%Y/Y in April. While the index measuring essential personal services increased 2.1%M/M and was down just 1.2%Y/Y, the non-essential services index increased just 0.6%M/M and was down 16.9%Y/Y, with activity in the living and amusement industry still down a whopping 28%Y/Y. The business services index increased just 0.2%M/M in August and was down 7.7%Y/Y, led in particular by weakness in the index capturing services provided to the manufacturing sector.

China inflation weaker than expected despite strong credit growth
China’s September inflation were notably weaker than expected. While the headline CPI rose 0.2%M/M, base effects meant that this lowered annual inflation by a steep 0.7ppts to 1.7%Y/Y – 0.2ppt below market expectations. Almost all of the decline in annual inflation could be attributed to food prices, where inflation eased to 7.2%Y/Y from 11.2%Y/Y previously, with increased inflation in fresh vegetables more than offset by stabilizing prices for pork (down 1.6%M/M, causing annual inflation to halve to 25.5%Y/Y). Non-food prices increased 0.2%M/M, but this simply left these prices unchanged from a year earlier. The core CPI – ex food and energy – also increased 0.2%M/M, but this left annual inflation at the 10-year low of 0.5%Y/Y reached in July.

Meanwhile, the inflation pipeline appears even more subdued with the PPI output index rising just 0.1%M/M in September and so falling 2.1%Y/Y – 0.1ppts weaker than market expectations, in contrast to the slight strengthening that the market had expected. The PPI for consumer goods rose fell 0.1%M/M, resulting in an annual decline in prices of 0.1%Y/Y too – the first negative reading since June 2016. And the decline in prices is even more pronounced when one ignores higher food prices, with prices for durable consumer goods and clothing down 1.9%Y/Y and 1.7%Y/Y respectively.

While today’s inflation data was soft, yesterday’s money and credit data for September added to the range of indicators pointing to a strong lift in real activity in the economy which, if maintained, should help to support inflation over time. Aggregate social financing increased CNY3.5bn during September – about CNY0.5bn above market expectations and CNY1.0bn above the same month last year. As a result, the outstanding stock of aggregate social financing increased 13.5%/Y, marking the fastest pace of growth since 2018. Bank loans picked up to CNY1.9bn from CNY1.3bn in August, largely driven by an increase in lending to corporates. Meanwhile, growth in the money base increased 1.7ppts to 11.1%Y/Y and growth in M2 increased 0.5ppts to 10.9%Y/Y – the former the fastest pace since January 2019 and the latter just shy of the 4-year highs reached in Q2.

RBA’s Lowe says won’t hike until inflation at target, moots buying longer bonds
A key focus today was a speech given by RBA Governor Lowe to an investor group in Sydney, titled “The Recovery from a Very Uneven Recession”. Unavoidably, the key focus for markets was on Lowe’s comments on the outlook for monetary policy, even though much of the speech was concerned with detailing the variable impact of the pandemic on the economy and how fiscal policy, in particular, had helped support the economy.

Importantly, Lowe noted that the Board had agreed that he make certain comments today, providing some context as to how its thinking about forward guidance is evolving. Over recent months, the RBA’s communication has stated that the Board will ‘not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2-3 per cent target band’. However, there has been considerable debate amongst investors about how this commitment should be interpreted. Today Lowe noted that the Board wants to see more than just ‘progress towards full employment’, given its view that addressing the high rate of unemployment is an important national priority. More significantly, he said that the Board will not increase the cash rate ‘until actual inflation is sustainably within the target range. It is not enough for inflation to be forecast to be in the target range.’ This means that policy tightening will be even more distant than would otherwise have been the case. Indeed, given the Board’s current outlook for the economy, they still do not expect to be increasing the cash rate “for at least three years”.

Given that outlook, Lowe reiterated that the Board is continuing to consider what more it can do to further aid the recovery. While noting that no decisions had been taken, he did outline three of the issues that are being discussed as part of that consideration, casting light on the Bank’s next moves.

First, Lowe repeated a previously made comment that further monetary policy easing would likely gain more traction as the economy begins to open up. So slightly paradoxically, the improving virus situation in Melbourne is likely viewed by the Board as a reason for implementing further policy easing, rather than a cause to sit on its hands.

Second, the Board is considering the possible effect of further monetary easing on financial stability and longer-term macroeconomic stability. Here the Board appears more sanguine than in the past, with previously-expressed concerns about asset prices balanced by the perceived benefit that returning people to employment would have for private balance sheets.

Third, the Board is considering how policy is evolving overseas, given the impact that this would have on Australia’s yield curve and exchange rate. And in that regard, during the post-speech Q&A, Lowe noted that Australia’s 10-year bond yield is higher than most everywhere in the world, which has prompted the Board to consider whether extending the maturity of its bond purchases would be beneficial to the economy (albeit that financial contracts in Australia tend to be linked to the three-year part of the curve). So overall, the clear impression left by the speech is that the RBA will be taking some further policy action soon, which could be a combination of a slightly lower target for the cash rate and 3-year bond rate and a programme of purchases of longer-term bonds.

As far as the rump of the speech was concerned, Lowe noted that the unevenness of the recovery was especially evident in the labour market. As elsewhere, job losses had been greatest for young people and the lower paid, reflecting the particularly large impact of the pandemic on the hospitality industry. And he noted that whereas payrolls at firms with at least 200 employees had fallen just 1% since March, payrolls had fallen about 7% at smaller firms. The unevenness was also apparent across states, with payrolls down over 8% in Victoria but only about half of that in New South Wales. And he noted that in Western Australia, where payrolls are now down only 1% – after being down over 8% in mid-April – the bank’s business liaison was even turning up reports of some labour shortages.

Australian employment down, unemployment rate nudges higher
Against that backdrop, as far as data were concerned, the key focus in Australia today was the Labour Force survey for September. According to the survey, employment fell 29.5k during the month, marking the first decline since May, led by further job losses in the state of Victoria (employment was up marginally in New South Wales and up solidly in Queensland). The decline was smaller than market expectations – even more so after allowing for an 18k upward revision to job gains in August, which is now reported as an increase of 129.1k. Full-time employment declined 20.1k in September and has declined 328k since February. Part-time employment fell 9.4k in September and sits 86k below February’s level.

While employment declined during the month, aggregate hours worked increased 0.5%M/M. Even so, aggregate hours worked were still down 5.0%Y/Y – more than the 2.8%Y/Y decline in employment – implying an unsurprising reduction in average hours worked per employee over the period. With employment falling slightly and the labour force participation rate steady at 64.8%, the unemployment rate edged up 0.1ppt to 6.9% – a smaller increase than the market had expected coming after an unexpectedly sharp decline in August. So when it release new forecasts next month, it is very likely that the RBA will revise down its forecast that the unemployment rate will peak at 10%. Finally, the broader measure of ‘underemployment’ also ticked up 0.1ppts to 11.4% in September, up from pre-pandemic level of 8.6% in February.

EU Summit likely to pass without escalating hostilities with the UK
The latest EU Summit gets underway this afternoon with leaders set to discuss progress in the negotiations with the UK on the post-transition relationship. PM Johnson had previously threatened to walk away from the talks if there was no deal by this week. But, of course, there has been insufficient progress on the key outstanding issues of the level playing field (including state aid rules), governance and, rather absurdly given its tiny economic importance, fishing rights. And given his failings in tackling the coronavirus pandemic, Johnson has little political capital to use on a self-defeating tantrum with the EU this week. So, while the EU leaders will likely bemoan the lack of progress and agree to step up contingency preparations for a possible ‘no deal’, Johnson will likely tomorrow choose to remain engaged with the negotiations.

Data-wise, the Bank of France will publish its retail sales estimates for September, although these proved an unreliable guide to the strength of sales in August. In Italy, meanwhile, industrial orders and sales data for August will be published and might suggest that manufacturers will see some scaling back in activity in coming months following surprisingly strong growth in August. And in the UK, the BoE will publish its Credit Conditions survey for Q3, which will provide details of projected lending conditions for the next three months.

Final French CPI inflation figures for September, just released, confirmed the flash estimates, which saw the EU measure slow 0.2ppt to a four-yer low of 0.0%Y/Y. With the flash estimates from Germany and Spain also having been confirmed earlier this week, tomorrow’s final euro area figures are also highly likely to confirm to the preliminary estimates, which saw the headline rate drop 0.1ppt to -0.3%Y/Y - the lowest since April 2016 - and the core rate fall 0.2ppt to a record low of 0.2%Y/Y.

Today's US data
Today’s US data-flow will bring the usual weekly claims figures, which have suggested little improvement over recent weeks, along with the October Empire Manufacturing and Philly Fed survey results. September export and import price data are also due. 

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