by
Dr Stephen Nash | Oct 15, 2013
International economic conditions assessment
Overall, the assessment of global growth was downgraded relative to September, with a somewhat more sober assessment in general and the US in particular. Specifically, we note the following assessment of the US given in September below,
Members were briefed that the US economy had continued to expand at a moderate rate, notwithstanding the effects of fiscal consolidation, and the housing market had strengthened a little further, with widespread increases in housing prices across the country. Employment had been rising moderately since the start of the year (September minutes).
Now, compare this to the October assessment, as shown below,
While the US economy continued to grow at a moderate pace, the latest payrolls data showed that employment growth had slowed a little in recent months. Members noted that the weakness in the labour market had been associated with softer consumption, and there were signs that the fiscal consolidation was weighing on economic activity. There was some evidence that the tightening in financial conditions over recent months had lessened the demand for mortgage finance, but the housing market overall continued to show signs of improvement (October minutes)
A downgrade in overall growth is apparent from this comparison.
Domestic assessment
Monetary policy was observed, once again, to have obtained more traction throughout the economy, as shown by an improvement in the outlook for dwelling investment and the auction clearance rate, given the impact of low interest rates. The following points provided additional domestic market commentary a subdued labour market was apparent, and only modest prospects for labour force growth are apparent
- Consumer spending was, again, observed to have remained below average, although sentiment had improved to “clearly” above average levels,
- Business conditions remained below average, leading to aversion to new investment, although the lower currency was seen as boosting some industries, such as tourism,
- Wages cost growth was generally seen as remaining low, while the labour market was observed as having “softened further in recent months”
Importantly, the RBA noted that the outlook for the construction sector was improving, although not overly strong, with forward indicators supporting improvement,
Dwelling investment had declined a little in the June quarter following a soft patch in building approvals earlier in the year, but dwelling construction remained higher than a year earlier and forward-looking indicators pointed to a further recovery in the second half of 2013.
Financial markets
Here, the RBA noted that the fiscal issue that plagued expectations of growth is still important to markets. As the RBA note,
The Federal Open Market Committee's economic outlook had changed little from the time of its June meeting, when the possibility of the Fed scaling back its asset purchases had first been signalled. However, the Fed was now seeking more certainty about the outlook before it began scaling back these purchases. In addition to discussing the prospects for US monetary policy, Board members noted the uncertainty in the US fiscal environment, with a shutdown in the federal government likely and the US government's debt ceiling being reached around mid October.
Also, the RBA highlighted that interest rates were now at “low” levels.
Considerations for monetary policy
Sub-trend economic growth, slowing wages growth, a high AUD, a cautious consumer, combined with sub-trend employment growth and a declining level of business investment, all supported the general background behind the easing in August. This was still much the same in the September meeting, and this background supported a continued easing bias guidance by the RBA.
The Board's judgement was that, given the substantial degree of policy stimulus that had been imparted, it would be prudent to leave the cash rate at the existing low level while continuing to gauge the effects. Members agreed that the Bank should again neither close off the possibility of reducing rates further nor signal an imminent intention to reduce them. The Board would continue to examine the data over the months ahead to assess whether monetary policy was appropriately configured.
While the RBA had seen that there was scope for further easing in monetary policy in prior releases, the RBA highlighted that the impact of low interest rates was becoming evident,
The effect of low interest rates was evident across a range of indicators and had further to run. House prices and turnover had increased and leading indicators pointed to a pick-up in dwelling investment over the period ahead. While credit growth remained moderate, there were signs of an increased appetite for borrowing, most notably among investors.
In other words, the RBA indicated that we have come a long way and that a period of assessment was now in play with regard to additional stimulation. As the weakness of the economy becomes more apparent next year, the cheapness of longer bonds should become more apparent, which then should lead the yield curve to flatten; long bond rates will more closely approximate the current level of short bond rates.
Conclusion
Markets have now come to the opinion that there is little prospect for additional easing by the RBA in the short term and are nervous about a surge of business investment in the wake of the recent election. This means that financial markets may begin to price in a small tightening of rates in the next few months, leading the yield curve to flatten further. In contrast, while we think that those expectations for another easing may well be realised in 2014, the financial markets may well overreact to the current short term growth spurt; something they are famous for doing. Overall, we estimate that cash rates will be left roughly unchanged in the post-election period, as nine months of pent-up investment commitments are finally executed. Such execution of plans should see short term activity surge, and markets seem to be sensing this and are pushing up three year bond rates as a result.
Apart from other things, a cash rate that equals the medium term inflation rate will mean that investors need to obtain better returns, when compared to cash, in the fixed income markets, so as to smooth turbulence from somewhat optimistic equity markets.