RBA hangs its hat on inflation – Minutes very cautious though

You have to love Central Bankers there is always something in what they say and write for everyone. So it was today with the release of the minutes from this month’s RBA Board meeting.

My takeaway was that I was surprised just how dovish these minutes were before the re-intensification in European sovereign issues, before the escalation of US Debt Ceiling issues and prior to the weak NAB Business survey and Westpac Consumer Confidence survey.

So me the take away was one of wow, they do get it and they are concerned about offshore events and household pain. But they still can’t give up on the mining boom and the impact this will have on the economy nor their concern about the possible re-emergence of inflation in the economy.

In the end they have clearly bought themselves more time to work out what they should do but they have hung their hat on next Thursday’s Q2 CPI release as a possible near term trigger.

That is as it should be, they are managing to the medium longer term after all. But even with a huge number it would be difficult to justify a hike  in the current fractious economic and market environment. And anyway the economy is just too weak in my view.

Lets have a quick look at the key points in the Minutes (link here)

On Financial Markets:

Developments in Greece had again been the main factor influencing markets over the past month. Pessimism had been the dominant theme until late June. Sentiment improved after further fiscal measures were formulated and passed by the Greek parliament.

Comment – I reckon things have changed a little in the past couple of weeks

Despite these movements, there was little sign of the tensions in the wider global money markets that had been evident in May 2010, when the Greek fiscal concerns first came to the fore, or in 2008 after the failure of Lehman Brothers. Members noted that spreads in the interbank market were little changed…Australian credit markets continued to be relatively unaffected by the global uncertainty over the past month. Issuance by Australian banks, both secured and unsecured, had remained solid and pricing had not materially changed.

Comment – things have deteriorated since the Board meeting as the Aussie Bank CDS chart from Bloomberg below shows

 

 

 

 

 

 

 

International Economy:

The pace of growth in the global economy had eased over the past few months, although this partly reflected the Japanese supply-chain disruptions, which would probably lessen over the months ahead. While the IMF had made a small downward revision to its outlook for world growth in 2011, its central forecast was still for growth to be at, or above, average in both 2011 and 2012. Downside risks had, however, increased, particularly because of the fiscal and banking problems in Europe…The difficulties in Europe, particularly Greece, remained a significant downside risk for the global economy.

Comment – its ok but we are worried would be my take on things.

In the United States, a range of indicators suggested that growth had moderated in recent months. The recovery in consumption had lost momentum, which members attributed in part to households adjusting to higher oil prices. The housing sector remained extremely weak and the pick-up in employment had been disappointingly slow. As in many countries, the recent industrial production data had been affected by supply-chain problems in the automotive industry, although machinery and equipment investment had been growing solidly.

Comment – not much needs to said about this one – still the world’s largest economy and its weak.

On the Australian Economy

The multi-speed nature of the Australian economy was clearly evident in recent economic data. The resources sector remained strong, as did some service sectors. However, household cautiousness and the high exchange rate were having a dampening effect on a number of other sectors. Supply-chain disruptions, due to events in Japan, had also caused a fall in motor vehicle production and sales. Survey measures of overall business conditions and confidence showed significant differences across industries, but overall conditions remained around their long-term averages.

Comment – they are getting it about households and nothing is really booming beside resources.

The unemployment rate had held steady at 4.9 per cent in May and had been around this level for about six months. Employment growth had slowed from the rapid pace in 2010, partly due to slower growth in the estimated working-age population.

Comment – This is really important. Glenn Stevens gave a speech which I have quoted from before where he said that an economies economic growth rate must slow, for any given level of productivity, if there is not enough available labour around.

The strong demand for mining-related occupations had led to increased wages pressures in some of these areas, but these pressures remained fairly localised. Overall growth in wages was running around the rate seen prior to the downturn, although the weak growth in measured productivity meant that unit labour costs looked to be rising strongly.

Comment – So wages aren’t really rising across the board which is good for inflation even if productivity looks weak.

The household sector continued to be cautious in its spending and borrowing behaviour. Following a solid rise in April, data for retail sales for May had shown a fall, although imports of consumption goods (excluding motor vehicles) had been strong over the past couple of months. Despite official data recording quite strong growth in disposable income and overall measures of consumer sentiment being around their long-run average, households’ perceptions about the state of their finances remained well below average. There had been little growth in nominal wealth over the past year, with housing prices having softened and equity prices lower recently. Members observed that this was in contrast to the experience of much of the past two decades. Housing credit growth had eased further, to its slowest pace in many years, although housing loan approvals had picked up in April and May.

The housing market remained soft, with nationwide measures of prices recording another small fall in May, although with some differences among cities. Mortgage arrears rates had risen over recent months, although they were still much lower than in most other countries. Arrears rates had increased the most in Western Australia and Queensland, where house prices had been falling after large run-ups in previous years. Members observed that this was similar to the pattern seen in Sydney following the rapid growth in house prices in the early 2000s: households that entered the market around the peak in prices, when lending standards were less stringent, had been more likely later to experience difficulties. In contrast, the arrears rates for borrowers who purchased their home in 2009, when lending standards were tighter, were not particularly high compared with earlier cohorts, despite these borrowers experiencing a significant increase in interest rates since they took out their loans.

Comment – that series of thoughts speaks for itself. My bolding for the key bits but in summary I think they are saying – households are under pressure and we are concerned. Also I think they might be worried they just burst the housing bubble – if there was one which I don’t necessarily think there is but we do think prices are biased lower.

The outlook for investment continued to be very strong, driven by the mining sector. Some companies were reporting rising costs in resource investment projects. A number of large LNG projects were under construction or progressing through the approvals process, and there was a high level of spending on projects to expand production capacity for iron ore in the Pilbara. Consistent with this, capital imports had trended higher over recent months. In contrast, investment in the non-mining sector remained soft, with signs yet to emerge of a pick-up in non-residential construction.

Comment – bifurcated economy. Mining boom is not getting into the rest of the economy.

Conclusion – Considerations for Monetary Policy

While the central scenario for the world economy showed robust growth over the coming year, global growth had slowed in the June quarter. The downside risks associated with a possible adverse European financial shock looked more significant than had been the case a few months ago. Whether the slower global growth would persist was unknown. Growth in China had slowed somewhat, although it remained strong overall.

Comment – wow that is a step back from may

Members noted that with households remaining cautious and the impact of earlier fiscal measures abating, growth in aggregate demand was not showing signs of a further pick-up yet. The pace of employment growth had for some months been more moderate than had been the case in 2010, and the overall labour market was therefore not tightening significantly further at present. A number of indicators were consistent with overall growth at around average pace with noticeable differences between sectors. The delays in the recovery of coal production and supply-chain disruptions resulting from the Japanese earthquake and tsunami also meant that GDP growth through 2011 was unlikely to be as strong as earlier forecast, with some of the recovery being pushed into the early part of 2012.

Comment – speaks of weakness and at best average outcomes. This is not a rate hike scenario.

To reiterate what we have been spruiking here and in other places since the start of the GFC – IT’S ALL ABOUT AGGREGATE DEMAND. It’s weak and is not likely to recover until Australia’s households and consumers rebuild their balance sheets to such an extent that they are comfortable to spend again. to this end we are in the midst of a spending drought which will pass in time but like meteorological droughts the timing is uncertain.

And finally after all for the concern comes the little bit to remind people of the RBA’s central tendency.

Notwithstanding this, members considered that the continuing strong economic performance of Asian economies meant that the medium-term outlook for the Australian economy remained strong. The prices of Australia’s main commodity exports were at elevated levels, and very strong growth in investment, led by the resources sector, was still expected over the next couple of years.

The extent to which these forces would strain the economy’s productive capacity over time would be a key determinant of inflation. Members noted, however, that the flow of recent information suggested both that there was more time to assess the likely strength of inflationary pressures in Australia and that it would be prudent to use that time. Members noted that the CPI outcome for the June quarter, to be published later in the month, would be important in helping to shape views about inflation, and therefore the future path of interest rates.

Comment – they still hold their central tendency but only a massive CPI number could possibly be the catalyst to hike. More likely though to achieve their other aim of jawboning consumers into submission without actually having to hike again.

All in all I think this a very dovish set of minutes from a central bank that has been taken aback with the scale and persistence of household retrenchment. They have not changed their central tendency one iota but what they have done is taken note of the risks around it and are ameliorating their outlook as the changed circumstance requires.

Evidence for me we have the best central bank in the world here in Australia.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

 

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