Weaker regional and global growth is ill-timed for Australia, given downward local pressures coming from the consumer and from housing.
Following a 27-year uninterrupted growth run, consumer debt levels and house prices reached high levels. But with wage growth and household savings both low, consumers are in a vulnerable position; sentiment has recently slipped to below-average levels and a softening in the labor market or further falls in house prices could cause consumers to rebuild precautionary savings. On the housing front, both dwelling prices and residential construction look set to record further falls under the combined weight of earlier prudential tightening measures, reduced foreign buying, more cautious bank lending and uncertainty regarding future tax changes, with a national election likely in May.
On balance, we look for below-consensus and below-potential GDP growth of around 1.9% this year and expect the unemployment rate to rise over the next six months. In turn, we expect inflation to continue to drift below the bottom of the Reserve Bank’s 2-3% inflation target band, and look for two 25 basis point rate cuts over this period, most likely in July and August.
This suggests a positive outlook for AUD rates at the front of the curve. We are somewhat surprised by the strength of the recent rally in these rates, as our view has come to be embraced by many, but advocate a buy on dips approach here. Our view also implies caution on the AUD; we think this could trade in a 68-70c range over coming months.
Rates Strategist, Australia
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