RBA won’t hike, can’t hike!

 I am baffled at the disconnect between some commentators in the media and in the markets and what appears to be going on in the households of Australia. So I have appointed myself Governor of the RBA, in a parallel universe, and written the statement I think the RBA should release Tuesday afternoon at 2.30pm. It’s published <here> at MacroBusiness. I think you’ll enjoy it.

Note that as Governor I’m:

  • Less concerned about commodity prices noting they have slowed and inflationary pressures will ease a little
  • Believe that monetary policy works in other jurisdictions not just Australia, hence global slowing
  • Recognises that Q1 growth in Australia was weaker than forecast making it difficult to hit the RBA targets, particularly as Q2 sees a 1.4% growth number drop (that means growth has to be 1.4% this quarter just to stay at 1.0% yoy as in Q1)
  • Is not so sure about the strength in employment
  • Think household retrenchment and lack of credit demand are enduring and, crucially
  • Recognises that the risks around the central tendency are rising

So no chance of this Governor hiking rates this month or any time soon. Households are so close to the edge that I want to see the whites of inflations eyes and if I do it’s two short sharp rate hikes to knock things over. That’s all it will take.

But I also want to take issue with one article over the weekend by Michael Pascoe I read. First let me say that Pascoe, more often than not seems to be on the side of right but I think his recent trip to WA to see the size and scale of things and no doubt to ride around on “Yellow Metal” has made him focus a little too much on the 8% of the economy that mining represents and forgotten about the other bits that remain under pressure.

He does make the very good point that for the moment the RBA is on hold again when he says,

This Tuesday, you’re likely to find the present reality somewhere between the two; the boom and the pressures it will create not yet arrived, and the tabloid-reinforced tales of woe unproven beyond everyone’s last electricity bill.

So the hard decision the governor has promised that you’ll have to make – an interest rate rise or three – can be left for the first Tuesday of another month. The battle of consumer confidence, fear versus ebullience, has played another draw.

But I think he then goes on with a bit too much hyperbole about the transmission mechanism between the mining boom and your average Australian. Economically this is our key area of focus here at Lighthouse because if we can get this right then it informs and influences out investment decisions and those of our clients.

But this transmission mechanism of mining wealth is not filtering through to the broader economy yet and is not yet showing signs of filtering through. If it is ok for the RBA to say in last months Statement after the Board meeting that wage rises in mining are not filtering into the broader economy then isn’t the corollary that neither is the wealth. So far it is absent as households pay down debt and save money.

Now certainly as incomes rise spending can increase at the same time that saving does but for the moment Australian’s are persistent in their pursuit of debt reduction. This is a really good thing because it insulates the economy from shocks down the track given that less leverage generally implies less risk from shocks. But just a couple of years into this readjustment in the spend/save equation after a multi-decade boom in borrowing isn’t it a bit early to expect this trend has run its course.

Which brings me back to Pascoe’s article where he says,

The RBA provided the first solid prediction that March quarter gross domestic product would be negative, though it’s possible the final minus 1.2 per cent was a fraction more than it anticipated. Even with that negative start to this calendar year and assuming an interest rate rise, the best and brightest of your RBA staff reckon GDP growth will be 4 per cent or so by December 31. That is amazing.

Yep it is amazing and very unlikely to be achieved.

To wit, at the risk of being accused of further data mining, we thought we’d have a look at the GDP result a little further. Not so much as a further breakdown in the numbers we just saw but more in terms of where the outcome was relative to where the RBA said it would be at the May SoMP and what this implies for their forecasts. The chart of the SoMP forecasts is below

Firstly note that the number was substantially weaker than the RBA had expected. The outcome was the white line where the RBA’s expectation was the pinkish line.

 Secondly, note in this Screen Shot of the GDP outcomes from Bloomberg, that the June quarter number for 2010 which drops out at the next release was a pretty healthy qoq outcome of 1.4%. So for the Australian economy to maintain even its anaemic 1% yoy growth we saw in Q1 2011 GDP for Q2 has to print 1.4% as a start just to stand still.

So, to achieve the RBA forecast embedded in the SoMP we need to see 2.9% growth in Q2 then 1.275% in both the 3rd and 4th quarters. To put this in perspective, check out the table, Australia has not printed 3 quarters of GDP growth above 1% since 2003. We never say never and it’s not impossible but it does put a lot of pressure on coal to bounce back, we wonder about the extra throughput Gladstone can handle to get us there, and puts extra pressure on the investment sector generally to make up for household caution.

Pascoe finishes by saying (my bolding),

Arraigned against that promise (the amazing numbers above – GMc) are headlines about falling house prices (exclude luxury homes and Queensland beach resorts and the reality is healthily flat), rising mortgage defaults (actually only up a little), retailers having trouble adjusting to competition from technological change (hey, try newspapers), fear and loathing about a carbon tax that, if it gets up, few will even notice (arguably the extremely aggressive and negative federal opposition campaign has started damaging the nation, not just the government), scary headlines about the US and European economies (but they are not our economy, we’re part of Asia) and the RBA promising interest rate rises.

Consumer, business and market psychology are collateral damage of this battle between the headlines and forecasts.

To say that the 92% of the economy that is not mining is mere collateral damage and imply that the concerns of business and households are less important in the economic scheme of things to me seems a little rich. We are at best 2 rate hikes from a serious household and economic tipping point. Thank goodness Martin Parkinson from Treasury is now on the Board to balance out the RBA boffins.

We don’t think anyone really thinks that the RBA will hike rates tomorrow and it is probably too soon after their SoMP in May to change their rhetoric but the risks around their central tendency of mining induced boosts to the economy are growing. It’s still a good economy but it’s not super strong.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

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Trackbacks/Pingbacks

  1. RBA won't hike, can't hike! | Lighthouse Securities | Brisbane Real Estate - June 6, 2011

    […] The rest is here: at this website […]

  2. RBA on hold…INDEFINITELY | Lighthouse Securities - June 7, 2011

    […] “The resumption of coal production in flooded mines is taking longer than initially expected, but production levels are now increasing again and there will be a mild boost to demand from the broader rebuilding efforts as they get under way.” Interpretation – we are not, REPEAT NOT, going to see a quick snap buck in GDP and the RBA is going to need to revise down its growth forecasts as we wrote yesterday. […]

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