Strong recommendation to manage rate risk.
On March 17 we revised our forecast for the Reserve Bank's cash rate.
We no longer expect that there will be 2 more rate cuts in this
cycle. We expect rates to remain on old until the second half of
2015. Essentially that means that for borrowers now is likely to be
as good as it gets.
In the note to customers, explaining our change of view we made the following points :
"Our dominant theme in this cycle has been that a weak labour market would undermine consumer spending which in turn constrains investment, employment and incomes. Businesses react negatively to soft demand; an uncertain global environment and a "still high" AUD. Those forces are expected to be complemented by a number of known headwinds - mining slowdown; fiscal restraint; falling terms of trade and a resilient AUD as global growth, including in the US, disappoints.
We still see those forces operating to moderate growth and inflation pressures but now assess that better news on employment; consumption; and business confidence will dampen those contractionary forces to exclude a sufficiently strong case to cut rates. This is in the context of a high hurdle from the perspective of the Reserve Bank to further cutting rates.
The upward revisions to the current state of the labour market as indicated by the February jobs report where jobs growth in February was reported as 47,300 (80,500 full time) and January was revised up from –3,700 to 18,000 painted a much more normal picture of the Australian jobs market.
That meant that the dismal start to 2014 of –10,400 in the previous 3 months was revised to a modest but respectable 41,000 over the three months to February. We accept that there were probably sampling issues with this report but that revised picture of the labour market now seems more consistent with recent lead indicators of employment intentions in the business surveys (which have recently lifted).
It is true that the unemployment rate was unchanged at 6% and we still expect that the unemployment rate will increase from this point to reach around 6.5% by year's end. However, whereas before we saw the risks to that forecast to the upside they are now tilted to the downside.
We have been impressed by the momentum in household spending in the final quarter of 2013 (up 0.8% real); the upward revision in spending growth in Q3 from 0.4% to 0.7%; and the surprising 1.2% print for retail sales growth in January. That momentum is partly associated with the lift in Consumer Sentiment to a peak of 110 in November last year. The recent drop in the Index to 100 is indicating a slowing in that momentum in the second quarter but not to a pace that would, of its own, trigger a rate cut.
Dwelling approvals have lifted markedly. They are now up by 35% over the year to January 2014, indicating a solid lift to residential building in 2014. We have always anticipated that lift to construction activity but had expected that the slow down in the momentum in overall consumer spending would largely offset that boost. With consumer spending momentum holding up better than expected that offset is now seen to be less significant."
Despite the economy improving over the last few months fixed rates have stayed around current levels and are, indeed, markedly lower than they were back in October and November.
The current yield curve (bills vs fixed rates) is currently quite flat with the 6 month bill rate only around 0.6% below the 3 year fixed rate. This can change quickly if the economy and inflation were to pick up more quickly than we currently expect. Some economists expect rates to be rising in the second half of 2014.
Recall 2009 when the fixed rates jumped nearly 2% between February and August despite the Reserve Bank not actually raising rates until the October. Once again this advice is all about risk management. In the past we have emphasised the need to manage risk despite our long held view that rates can come down further.
Now that we do not expect lower rates, advice on risk management becomes even more important. Before, in our view, there was a real chance that rates would be markedly lower. Now we do not see that possibility as part of our central case.
I urge you to consult your relationship manager on the best strategy to manage your interest rate risk.
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