by
Dr. Stephen Nash | May 09, 2013
Even though we thought the RBA would wait, we have been consistently calling for two rate cuts in 2013, often in the financial “wilderness”, all year. Accordingly, we have the direction correct and expect that the cash rate to be 2.50% by the end of 2013.
Business leaders on the RBA board are focussing attention on the high Australian dollar and the continuing negative impact on the export sector, which has been compounded by the higher currency. Meanwhile, the consumer generally refuses to reduce savings and increase debt. In addition, scope for even more easing, than currently expected, might emanate from global developments, especially in Europe, where risks remain significant yet very difficult to predict.
As short term interest rates compress to the medium term rate of inflation, at around 2.50%, we recommend that clients get in front of the compression in interest rates that will occur as yields are now set to fall further.
Statement
The following points are evident from the statement:
- Global growth: Global growth comments were slightly more dovish than the prior meeting. With the recent ECB easing, this area of RBA consideration was positive for an easing. As the RBA indicates,
The global economy is likely to record growth a little below trend this year, before picking up next year. Among the major regions, the United States continues on a path of moderate expansion and China's growth is running at a more sustainable, but still robust, pace. Japan has announced significant new policy initiatives aimed at strengthening demand and ending deflation. The Euro area remains in recession. Commodity prices have moderated a little in recent months though they remain high by historical standards.
- Financial market developments: In general, the assessment of financial market developments was largely unchanged from the prior statement, where a growing recovery in sentiment became apparent. International financial conditions were seen as “very accommodative”. While accommodative, financial conditions need to remain so, in order to stimulate growth. Another positive for an easing.
- Domestic economic developments. We thought that of all the areas, this would prove difficult for the RBA. Some evidence of prior easing were beginning to be felt, and the RBA acknowledged as such today, where the RBA saw,
Savers have been changing their portfolios towards assets with higher expected returns, asset values have risen and some interest-sensitive areas of spending have increased.
However, inflation was observed to be well contained, unemployment has risen, and with the peak of mining investment to be seen this year, the RBA thought that there was “scope for other areas of demand to grow more strongly over the next couple of years”. We think that this is the essential point; while growth is emerging, current non-mining sector growth is just not strong enough to offset forecast declines in the mining sector. Sub trend growth, towards the end of the year, is still forecast, and this now is consistent with recent Commonwealth Treasury revisions, while an elevated high Australian dollar constantly dampens the manufacturing sector.
- Inflation: As labour costs remained “contained” and even a little “lower” than expected,
Recent data on prices confirm that inflation is consistent with the target and, if anything, a little lower than expected. The CPI rose by 2½ per cent over the past year, and measures of underlying inflation gave a broadly similar outcome. These results have been pushed up a little by the impact of the carbon price. Growth of labour costs has moderated slightly over recent quarters while productivity growth appears to be improving. This should help to lessen increases in prices for non-tradables. The Bank's forecast remains that inflation over the next one to two years will be consistent with the target.
- Final paragraph: Here, the RBA noted that it has now used “some” of the available scope to stimulate demand,
The Board has previously noted that the inflation outlook would afford scope to ease further, should that be necessary to support demand. At today's meeting the Board decided to use some of that scope. It judged that a further decline in the cash rate was appropriate to encourage sustainable growth in the economy, consistent with achieving the inflation target [emphasis added].
Other factors
Recent releases from Europe have been surprising economists and the RBA to the downside and we plot the rolling monthly changes in the Citigroup Economic Surprise Index in Figure 1. This index measures the degree to which economic releases exceed, or fall short of, consensus forecasts and negative readings on the scale tend to indicate that releases have fallen short of expectations. Notice, in particular, the very weak monthly changes in the European index, or the light blue lines, which have been followed by the US, or the dark blue lines.
Further weakness in European economic releases, as implied by Figure 1, especially if the recent trend of weaker than expected releases continues, may be one of the factors to force the hand of the RBA, again, towards the end of the year.
Conclusion
While most of the boxes for an easing had been “ticked” before the meeting, we thought that the emerging recovery in home prices, with elevated auction clearance rates, may have forced the RBA to wait a little longer, so as to avoid the problem of housing price inflation, that had been experienced in New Zealand. What is emerging in housing was, in our view, worthy of further careful examination before additional moves were to be made by the RBA. Yet, we have been calling for two more rate cuts this year for some time, often alone, or with very little support from other analysts.
So we have what we forecast; just a little earlier than anticipated.
The focus now is on what happens next, and the final paragraph leaves the door wide open for another easing. When the RBA moves, it typically moves at least twice and usually quite quickly, so the next easing could be as early as next month. However, we would think that the next easing might take some time and the third quarter seems about right to us at this point. In Australia, a structurally more conservative consumer is slowing the typical transmission of lower rates to activity at this point, and this is what is making the prospect of even further easing tantalisingly close; a point to be elaborated in the Statement of Monetary Policy on Friday. Further RBA easing will be needed to encourage borrowing, and thus non-mining growth from an extremely conservative consumer.