RBA to pare back pace of QE

Chris Scicluna

Crude surges as OPEC talks remain at impasse; mixed day for equities in the Asia-Pacific region; Aussie bond yields a little higher after RBA announces plan to pare back pace of QE and more equivocal about further rate path
With US markets closed in observance of the Independence Day holiday, there was little to guide markets in Asia other than a further surge in crude oil – WTI futures rising above $77.50/bbl after ongoing Saudi-UAE disagreement led to another breakdown in OPEC production talks. As a result, equity markets have been somewhat mixed. After closing down 0.4% yesterday, the TOPIX has erased that loss today even with local data reporting a decline in consumer spending and employment in May (albeit with annual growth very strong due to base effects associated with last year’s severe contraction). Finance Minister Aso told reporters that he is hoping that the Olympics lift the national mood and – even more optimistically given recent virus trends – that it would showcase the recovery in the Tokyo region. This comes even amidst reports that the government will, perhaps as soon as Thursday, extend quasi-emergency conditions in Tokyo and three nearby prefectures until after the games finish on 8 August, raising further questions about whether any spectators will be in attendance. While stocks also advanced solidly in Singapore and modestly in South Korea, markets lost ground in mainland China and Hong Kong.

In the Antipodes, the focus today has been mainly on the RBA, which announced the outcome of its latest policy review. We discuss the RBA in more detail below. But, in summary, the Board agreed to maintain its cash rate target at 0.1%; retain its short-term bond yield target at 0.1%, still applicable to the April 2024 bond rather than rolled to the November 2024 bond; but pare back slightly its pace of additional QE purchases to A$4bn per week once the current A$200bn cap is met in early September, subject to further review at the November meeting. More importantly for the longer-term outlook, the Bank also noted that its central scenario indicates that the conditions that would warrant a hike in the cash rate “will not be met before 2024” – arguably less definitive than the Bank’s previous advice that tightening was unlikely “until 2024 at the earliest”. The latter innovation perhaps explains why the 10Y AGCB increased a couple of bps on the day while the yield on the November 2024 bond increased almost 8bps to 0.44%, but the ASX200 declined 0.7%. Meanwhile, in a similar vein, Kiwi stocks fell, the Kiwi dollar gained and the 10Y NZGB increased 5bps to 1.81% following yet another upbeat business survey, which encouraged economists at two of the big four local banks to forecast a rate hike as soon as November this year.

Japan’s labour cash earnings rebound 1.9%Y/Y in May thanks to base effects
Today the MHLW released the preliminary Monthly Labour Survey for May, which presented a flattering account of Japanese wage and employment growth on account of the very weak base in May last year (which proved to be the trough during the first wave of coronavirus infections and associated lockdowns). At the headline level, total labour cash earnings (per employee) increased 1.9%Y/Y – just a couple of tenths less than the consensus expectation and up from 1.4%Y/Y in April, but failing to reverse the 2.3%Y/Y decline reported a year earlier. Earnings in the manufacturing sector outperformed, increasing 2.3%Y/Y, but only after declining 4.5%Y/Y a year earlier.  

Compared to last month, the lift in overall growth in wages owed to a 20.6%Y/Y rebound in overtime earnings following a 26.3%Y/Y decline a year earlier. The increase in overtime earnings reflects the recovery in overtime hours worked, which despite a 3.6%M/M setback in May – clearly influenced by restricted trading conditions – grew almost 28%Y/Y, but sadly following a near 31%Y/Y decline a year earlier. Bonus earnings grew just 1.0%Y/Y in May after declining nearly 11%Y/Y a year earlier. Meanwhile, regular earnings increased 0.8%Y/Y, which was unchanged from April but up from growth of just 0.1%Y/Y a year earlier. After accounting for inflation, real wages increased 2.0%Y/Y, but unfortunately, this follows a 2.3%Y/Y a year earlier.

Elsewhere in the survey, total hours worked declined a seasonally-adjusted 4.5%M/M in May but were up 8.8%Y/Y. Regular employment declined a seasonally-adjusted 0.2%M/M – the first decline since May last year – but thanks to base effects grew 1.8%Y/Y. Employment in the manufacturing sector declined 1.0%Y/Y. By contrast, reflecting demand created by the pandemic, employment in the medical, healthcare and welfare sector increased 2.9%Y/Y. According to the preliminary breakdown – which is often substantially revised – growth in the number of full-time employees picked up 0.4ppts to 1.3%Y/Y. Meanwhile, growth in the number of part-time employees – which had withstood the worst of the first wave of the pandemic – increased 3.3%Y/Y following a 2.4%Y/Y decline a year earlier. 

Base effects also flatter Japan’s household spending figures in May
In today’s other Japanese news, the MIC released its monthly survey of household spending and incomes for May. According to the survey, real household spending declined 2.1%M/M, marking the first contraction since January. But with spending having declined sharply last year at the onset of the pandemic, annual growth still stood at a very flattering 11.6%Y/Y – a little ahead of the consensus expectation, but down from 13.0%Y/Y in April. The measure of core spending, which excludes spending on volatile components such as housing and autos, declined 1.8%M/M following a 0.6%M/M decline in April. And so while core spending grew 8.2%Y/Y, it remained below pre-pandemic levels, which were themselves slightly depressed following the increase in the consumption tax rate in October 2019. Despite the decline over the past two months, at this point the survey has core spending tracking almost 3% above the average level through Q1. However, tomorrow’s release of the BoJ Consumption Activity Index – a far superior tracker of the national accounts measure of private consumption – is likely to point to spending tracking at least a little below the Q1 level. Finally, the survey’s (equally volatile) measure of workers’ real disposable incomes declined 3.9%Y/Y in May, with incomes in the previous year (May through July) having been boosted by ¥100k government support payments to residents.

German factory orders disappoint with marked drop in May, but Spanish manufacturing posts further strong growth
After yesterday’s French IP numbers disappointed, with evidence that supply bottlenecks with semiconductors were severely dampening autos production, this morning’s German factory orders figures underscored questions about the near-term production outlook in the euro area’s largest member state. Contrary to expectations of a further increase, factory orders slumped 3.7%M/M in May, the steepest monthly drop since April 2020. Admittedly this followed upwardly revised growth of 1.2%M/M in April and a cumulative increase of more than 6½% in the first four months of the year which had contrasted with the subdued performance of production. As such, orders were still more than 6% higher than the pre-pandemic level and up by 54.3%Y/Y. 

With domestic orders up 0.9%M/M (albeit this was more than fully accounted for by large one-off orders), the weakness in May reflected a sharp decline in overseas orders (-6.7%M/M), with those from the euro area down 2.3%M/M and new orders from elsewhere down 9.3%M/M. And this was driven by weak export demand for autos, with foreign orders of capital goods down 8.8%M/M (compared with a rise of 3.3%M/M in domestic orders of such goods). Meanwhile, orders of intermediate goods were down for the second successive month (-3.6%M/M), with weakness evident in both domestic and external demand. In contrast, new orders for consumer goods were up 3.9%M/M, to their highest level since mid-2018.

Looking ahead to tomorrow’s German IP data, this morning’s manufacturing turnover data raise some downside risks to the consensus expectation of an increase of ½%M/M in production. In particular, turnover fell 0.5%M/M to leave it still almost 5½% lower than the pre-pandemic level. Of course, like in France, this likely largely reflects supply constraints rather than softer demand. Certainly, manufacturers remain largely upbeat about the near-term outlook and this is likely to be echoed in today’s ZEW investor survey due later this morning. Indeed, investor perceptions of the current situation are expected to improve further, with expectations about the outlook over the coming six months likely remaining at elevated levels too.

In marked contrast to developments in Germany and France, this morning’s Spanish IP data exceeded expectations, with output jumping 4.3%M/M in May, the third consecutive monthly increase to leave it almost 4% higher than the pre-pandemic high. This was in spite of a significant decline in production of motor vehicles (-16.1%M/M). Indeed, production of electrical products and equipment jumped in May, supporting a 12.7%M/M increase in overall output of consumer durable goods.

Euro area retail sales data to report solid growth in May
This morning will bring euro area retail sales figures for May, which, in line with the strong growth seen in Germany and France and supported by the easing of restrictions across member states, are expected to more than reverse the drop of 3.1%M/M in April. June construction PMIs from the euro area and various member states are also scheduled for release.

UK construction PMI to remain elevated in June
After an upwards surprise to the UK’s final services PMI yesterday, this morning’s construction PMI release is similarly expected to show the headline activity index remained at an elevated level in June, close to the near 7½-year high of 64.2 recorded in May.

ISM services survey the focus in an otherwise quiet US day
Following yesterday’s holiday, the ISM services for June is the key economic release today, albeit probably carrying less weight than usual with the June employment report already released last week. Daiwa America’s Mike Moran expects the headline index to remain close to last month’s record reading of 64, while Markit’s less-followed services PMI should print in the same ballpark based on last month’s flash reading.

No surprises from the RBA as flexible QE is adopted in face of improving conditions; but signs of less certainty that the cash rate will not be raised before 2024
The focus in Australia today was on the RBA, with the Board announcing the outcome of its review of policy settings, which this month included decisions regarding the future of its 3Y bond yield target and its QE programme. The key outcomes of the meeting were as follows:

  • As had seemed certain, the cash rate remained at 0.1% and the rate on Exchange Settlement balances at 0.0%.
  • As had also come to be viewed as certain, the Bank elected not to roll its 0.1% target for the 3Y bond, which thus will continue to apply to the (now less than 3Y maturity) April ’24 bond rather than the November ’24 bond.
  • Once the current QE programme reaches the A$200bn cap in early September, the RBA will make further purchases at the rate of A$4bn per week – A$1bn below the present rate – until at least 11 November, with a further review to take place at the Board’s November meeting when updated forecasts will be available. The allocation of purchases will be weighed 80/20 between AGS and semis.
  • The Bank advised that its central scenario is that the conditions that would warrant a rate hike “will not be met before 2024” – less definitive than the Bank’s previous advice that tightening was unlikely “until 2024 at the earliest”.

Elsewhere in the post-meeting statement, the RBA again noted that economic recovery in Australia is stronger than earlier expected and is forecast to continue. The Bank acknowledged near-term uncertainty related to the effect of the recent virus outbreaks and the lockdowns. However, it also noted that the experience to date has been that once outbreaks are contained and restrictions are eased, the economy bounces back quickly. Yet again, the Bank noted that the labour market has continued to recover faster than expected, including a welcome decline in underemployment and a labour force participation rate around record highs.

But despite the strong recovery in jobs and reports of labour shortages, the Bank is mindful that current inflation and wage outcomes remain subdued. And looking ahead, while a pick-up in inflation and wages growth is expected, the Bank continues to forecast that this will likely be only “gradual and modest”. As a result, in the central scenario, underlying inflation is still expected to be 1½%Y/Y over 2021 and 2%Y/Y by mid-2023 – the latter at the bottom of the RBA’s 2-3% inflation target range. And given the Board’s ongoing commitment that it will not increase the cash rate until actual inflation is sustainably within the target range – and Lowe today suggested that it would need to be above 2% for at least a couple of quarters – the Bank’s central scenario for the cash rate is still that tightening will not occur before 2024.

Importantly, the Bank’s forecasts will be reviewed for next month ‘s Board meeting ahead of the publication of the Statement on Monetary Policy. And Lowe suggested that the projections were likely to see upwards revisions. The key data releases over the intervening period will be the June Labour Force report (15 July) and Q1 CPI report (28 July). In our view, it will likely not take much further upside surprise – especially if in the CPI report – for the RBA to bring its central scenario for a first rate hike into the latter half of 2023.

Kiwi businesses in expansionary mode; inflation pressures mounting
In common with the monthly survey run by the ANZ, the NZIER’s long-running quarterly survey of businesses pointed to a considerably lift in sentiment over the past three months with firms clearly in expansionary mode. A net 26% of firms reported in improvement in their own trading activity over the past three months, while a net 28% of firms expect further improvement over Q3. As a result, a net 22% of firms expect to boost hiring while a net 20% expect to boost spending on plant and machinery. Also in line with the pressures indicated by the ANZ’s survey, a net 39% of firms reported that they had increased prices in Q2 and a net 52% expect to do so in Q3. Labour shortages continued to intensify, with the overall shortage of skilled labour at levels not seen this millennium and the shortage in the construction sector at the highest level measured since the survey was first undertaken in 1976.

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