A$ hangs tough as rate cuts loom

After Monday, it was almost all negative news for the Aussie. On the data front, the first input to Australia’s Q1 GDP report due on 5 June was a disappointment, with construction activity contracting for a third consecutive quarter. Mining-related construction continues to fall but the main surprise was another quarter of contraction in public works. Given the extensive infrastructure plans and promises, this sector should improve but for now it is a drag on growth.

The regional mood was not helpful for the Aussie either, with notable declines in many Asian currencies and stability in the Chinese yuan only achieved as Chinese authorities made clear they were committed to acting to stem its fall. Pressure on the yuan intensified on a flurry of headlines claiming the US was taking action to block various Chinese technology firms from accessing the US market.

This doesn’t augur well for a trade deal any time soon though iron ore remains a positive for the Australian dollar, with the benchmark China iron ore price rising above $100 per tonne this week.

But obviously the main focus was the RBA on Tuesday. First we saw the minutes of the May Board meeting. This included the key line that quote “members considered the scenario where there was no further improvement in the labour market in the period ahead, recognising that in those circumstances a decrease in the cash rate would likely be appropriate” end quote.

This hinted that a rate cut was not far away, and sure enough, soon afterwards, we had confirmation from RBA Governor Lowe in a keynote speech that the Board was not content to wait and watch the labour market any longer before acting. Lowe said that in June the RBA would “consider the case for lower interest rates.” A June rate cut to 1.25% seems to be a done deal and there is no reason to believe it will be a one-off, with the debate now over when the cash rate will fall to 1% and whether that will be low enough.

In his speech, Governor Lowe returned to a recent theme in RBA commentary – the evidence of countries such as New Zealand, the US and the UK that unemployment can fall considerably further than previously thought before stoking inflation. For example, while Australia’s unemployment rate is 5.2%, the UK unemployment rate has fallen to 3.8%, the lowest since the early 1970s. This helped wages growth pick up to an enviable 3.5% by early 2019 but inflation is quite stable near the Bank of England’s 2% target. Its policy interest rate remains just 0.75%.

Australia’s week ahead is quiet aside from the Q1 private capital expenditure survey, another input to GDP. Most attention is likely to be offshore, with British PM May expected to resign, European Parliament elections likely to see a considerable protest vote against traditional parties and no doubt further turbulence in US-China relations. We will discuss these topics when we speak to you next week.