The RBA has a bias to tighten – But does the Board?

July 29, 2011

FOREX, RBA and Interest Rates

When you survive financial markets long enough you learn to hold strong views but be flexible enough to change your mind when the outlook changes and change your positioning when the market moves against you. With more than 2 decades playing this game and having been completely blindsided by the RBA on July 31st 1996 I am not about to say that there is no chance that they will raise rates next week.

My, indeed our, analysis suggests to us that the domestic economy remains weak and is in fact weakening. But the 0.9% CPI number released two days ago has the punditry and commenteriat salivating at the prospect of an imminent rate hike.

Indeed writing yesterday morning Terry McCrann said the RBA has no choice but to raise rates because

“the inflation tiger is out of the bag and running, before we get to actual spending of the resources investment boom which is going to add so much stress to demand for skilled labour, and so wages and inflation”.

The ANZ has likewise called for a rate hike yesterday afternoon saying that the Q2 CPI

…has brought inflation in Australia to an uncomfortably high starting point given the robust 2012 outlook. This necessitates a small adjustment to the policy rate.”

Crucially like old generals fighting the last war both McCrann and the ANZ say that the RBA is still smarting from the experience of Mining Boom Mark I. ANZ says,

“Memories of 2007/08 will make the RBA sensitive to being behind the curve on inflation. A small upward adjustment to interest rates now could well save the Australian economy from a painful series of rate hikes in 2012.”

This is true and even though I fear the household and consumption sectors will struggle with another rate hike I concede that if inflation skips away from us and the RBA has to hike a few times that the household sector and consumers generally and retailers in particular will suffer more.  So I have sympathy with both McCrann and the ANZ Economics teams’ view.

But I continue to think that the level of uncertainty is such that watching how things evolve is the better course of action for the RBA in the current environment, why the rush? 

I think that will be the discussion around the table at Martin Place next week – why the rush if the break-up of the inflation data suggests that things will moderate back to a fairly reasonable level in H2 2011. Indeed the monthly TD Inflation index is far more benign than the sharp spike in the ABS measure of CPI as the chart below shows.

As you can see the TD Inflation series (yellow and purple dashed lines) has already peaked and has come off quite markedly. Is this the future? We think it is as does the Federal Treasurer Wayne Swan who was quoted in various places yesterday as saying the spike was a one off. Indeed the Australian reported that,

TREASURER Wayne Swan has played down an inflation surge as he defended the government’s productivity agenda, saying its benefits would not be realised overnight.

Mr Swan said a summer of natural disasters and higher fruit prices were responsible for a stronger than expected increase in Australia’s consumer price index, which he accepted was making life harder for struggling families.

“These events are one-off events and they have a one-off impact on the CPI,” he said.

So getting back to next week’s RBA Board meeting we’d have to guess that at least one vote, Treasury Secretary Martin Parkinson who effectively works for Mr Swan will not be voting for a rate hike.

But what about the rest of the Board?

Certainly 2 votes for a rate hike from Glenn Stevens and Ric Battelino if they are as concerned as they have appeared about inflation and are still certain of their central tendency that the mining boom is decades long and the income will eventually flow through the economy.

Which leaves us 2 to 1 in favour of a hike.

Lets walk through the rest of the Board and see if we can figure out what they might be thinking by looking at who they are:

John Akehurst – John is a Director of CSL and Origin Energy and has previously been the CEO of Woodside. So I’m guessing he is feeling the pain of both the high Aussie Dollar and the uncertainty around the Carbon Tax.

I’ll put him down for a no vote – 2 all, no move.

Jillian Broadbent AO – Jillian is a Director of the ASX, Coca Cola Amatil and Woolies. I’m guessing that she is seeing the pain of corporate Australia and seeing the impact on the Household sector currently from the massive uncertainty. But she is a former senior Bankers Trust Australia Exec and also Chairman of the RBA’s audit committee. So I’m guessing she has strong views but that the banker and rationalist in her is also likely to be more open to a small move now in order to avoid bigger moves later.

I’ll put her down for a yes vote – 3 to 2, rates up.

Roger Corbett AO – Retailing runs deep in the veins of Mr Corbett and his current Directorships of Fairfax Media, PrimeAg, Mayne Pharma and Walmart will have him face to face with Australian and global economic weakness.

I’m putting him down as a no vote – 3 all, no move

Graham Krahe AO – Graham is Chairman of Bluescope Steel and Brambles as well as being a Director of listed investment fund Djerriwarrh Investments. He was NAB’s Chairman for a while and his Executive background is in diversified industrials and wine. I’m guessing, like Jillian Broadbent, he will see both sides of the story that the RBA staffers will be pushing  but that his sympathies will lie in the uncertainty faced by his other businesses which he is experiencing first hand.

I’ll put him on the fence but likely to vote no – 3 to 4, no move.

Catherine Tanna –  As a lawyer Catherine knows the value of a good argument and as a relatively new Board Member, having only been a member since March, it is likely that Catherine will still be swayed by the RBA staffers arguments. Equally as the MD of  BG’s Australian Gas Operations she is front and centre of the investment boom and skills shortage.

I’m putting her down as a strong yes vote – 4 all, it’s getting tricky now, but now move.

John Edwards – Our Final member of the Board is straight out of the wrapping and will be attending his first meeting as a Board member. John is an Economist of some repute, he was an Adviser to Keating before he went to HSBC as Chief Economist for 10 years  before moving on. In his time at HSBC I got to meet with John many times and he is both a very good economist and a very considered man. Even though he has strong Labour roots the Economist in him is likely to have much sympathy for the RBA staffers views.

My sense is he’ll side with the RBA staffers and vote for a rate hike – 5 to 4 rates go up.

MMMM…I wasn’t expecting that. I thought I’d get a resounding no vote when I set out to write this blog.

Now everything is predicated on the RBA staffers pushing hard that they having been telling the Board for month’s that inflation was a risk and to stop focussing on the weak retail sector lest inflation gets away from them.

So, for the big question – do I change my call?

I simply can’t. I am at the coal face, so to speak, of a region that has mining as its significant other on top of a well diversified economy with similar industry break ups to the national averages. There is no boom here or if there is it is very concentrated and has not seeped into the broader local economy. I understand why the RBA might hike next Tuesday but I just don’t think that with households in so much strife and focussed on paying down debt and with all the uncertainty offshore now is the time to hike rates.

I just have to be prepared to be wrong.

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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