Happy to be wrong

September 8, 2011

RBA and Interest Rates

I have never been so happy to be wrong as I was yesterday with the release of the National Accounts for the second quarter this year. I was delighted to see the print of +1.2% qoq growth and the revision to Q1 2011 GDP from -1.2% to -0.9%. I had thought the risk was to the downside given the ongoing drag of net exports and what I felt was a really weak household sector. But things are not always as they seem anecdotally are they.

Source: Billy Blog – http://bilbo.economicoutlook.net/blog/?p=15979#more-15979 

The result was driven by a bounce in household consumption (0.7%) but also by a large rise in inventories (0.8%). Now 1.2% growth qoq is pretty good but 1.4% growth yoy is not. So what did the data tell us about where the Australian economy is at?

Firstly I say I don’t want to disengenuous nor quibble with the data but it is representative of the way the economy was in the post flood/storm bounce 3 months or more ago. Equally however the data suggests that back in Q2 when the RBA was thinking about tightening, remember the May SoMP and all the calls for a June hikes, economic growth was, it seems, stronger than many thought. Data subsequent seems to paint a very different picture for activity this quarter but I have to ask myself am I falling into the same trap as last quarter – it is possible that I am overemphasing the weakness so I’ll have to stay wary of confimration bias and only searching for data that agrees with my view.

I think this is an important point in the context of some of the vitriolic stuff that I saw some of the more economically bullish commentators wrote yesterday and in particular where the RBA is now. I saw people being called names, I read borderline slanderous comments and in truth I felt like giving up this blogging game because I don’t want to be associated with that type of rubbish. Because the truth is  that all this data point did was tell us that the economy wasn’t as weak as some thought back then, me included. It tells us nothing about now – particulalry given all thats happen in the past few months.

But equally the bulls in the economic china shop need to look at their calls on interest rates and ask themselves how much money they would have cost people who listened to them. For example the 3 year swap rate in Australia on the 6th of May was sitting at 5.38%. This was the day the May SoMP was released and when the pundits were calling for rate hikes in June. By the 30th of June, when they were still calling for rate hikes in the next month or so, the rate was 5.17%. This morning it is 4.36%!!!

That is a lot of money being lost by a lot of traders, investors and corporations who listened to these calls for rate hikes and only those who don’t trade, advise or invest in the markets and thus have no transmission mechanism between their calls and hip pocket nerve impact could be so vitriolic about whats going on in the economy. This forecasting/investing game isn’t easy and you get it wrong sometimes but no need to take pot shots at those who hold a different view. I guess it’s probably a defence mechanism to try to justify past mistakes on calls with histrionics on historical data but it simply lacks credibility.

Anyway enough of that rant and back to the data.  

The second point I would make is that even though we have this massive mining boom going on our external sector continues to be a drag on growth. Bill Mitchell from Newcastle Uni summed this up nicely yesterday when he wrote

 “While the income from net exports of goods and services is rising (along with the terms of trade) so is the net income flowing abroad (net profits repatriation) and the latter outstrips the former by some margin.In other words, we are exporting our minerals like crazy but sending more of our income to foreign owners of our capital and debt. Net result: the external sector is a contractionary part of our economy.”

That’s interesting in terms of the long term benefits and impact of the mining boom and how much wealth we eventually capture for future Australian generations. Here’s a thought bubble – are we just the itinerant workers on our own land as all the benefits of the mining boom apart from employment go to the lords and lady’s of the big mining houses offshore? Exactly what is the benefit for the long run of all this investment when it simply puts more pressure on an almost already fully employed economy and drives our currency to the moon – just thinking not telling.

So it certainly peeked my interest when we are supposed to be experiencing an investment boom and the GDP data showed a reduction in Private investment in Q2 relative to Q1 2011. How this reduction is consistent with what we are hearing about investment I don’t know – but time will tell on this one.

 The third point of interest is the Household Savings rate which dropped back to 10.5 from 11.7. But as the chart above shows (I’ve used Bill Mitchell from Newcastle Uni’s charts from his blogg as I am having data base issues today – Bills was the best summary I read yesterday) you’d argue, and bill does that this is more normal than aberrant. He says,

The following graph shows how atypical the period of the budget surpluses were (from 1996 to 2007). As households increasingly went into the red and were dis-saving the household saving ratio became negative. As a result of the risk now carried by the record levels of indebtedness and the uncertain nature of the economy at present (threat of unemployment is still high), households are resuming their historically typical behaviour and consumption is more subdued as a result.

So what does it all mean for interest rates in Australia? I guess when we look at this data and then at Glenn Steven’s speech yesterday in Perth (http://www.rba.gov.au/speeches/2011/sp-gov-070911.html) we see that the data didn’t suggest a need to cut in a hurry and the Governor suggested he remains of the view that he doesn’t need to cut.

In Asia and other parts of the emerging world, however, ample policy ammunition is available, both fiscal and monetary, should the authorities have a need to use it. To do so credibly would presumably require confidence that the upward trend in inflation seen over the past couple of years would be likely to turn down. Of course, a significant weakening of the global economy would result in lower commodity prices and generally lower underlying inflation pressures. So far, the decline in major commodity prices has been fairly modest, though enough to help rates of CPI inflation to moderate a little.

In summary, the environment presents no shortage of challenges, though we should not assume that this is necessarily 2008 all over again. It is reasonable to conclude, at this point, that the outlook for global growth is not as strong as it looked three months ago. Forecasters are generally revising down global growth estimates for 2011 and 2012, mainly as a result of weaker outcomes for the major countries.

Turning back to the implications for Australia, periods of sudden increases in anxiety within international financial markets are moments when, if at all possible, it is good to be in a position to be able to maintain steady settings. In the recent few meetings, the Board has judged it prudent to sit still, even though we saw data on prices that were, on their face, concerning. To be in that position of course requires timely decisions to have been made in earlier periods.

My wordle cloud from yesterday may suggest that the RBA unconciously is moving toward cuts but the conscious mind has some way to go it would appear. Clearly as the Governor states above and then in his conclusion to his speech he believes that he and our Asian trading partners have the monetary tools necessary if there was a catastrophe offshore but that he wasn’t going to be cutting unless or until he sees inflation sustainably lower. Markets and economies might be volatile but at least the RBA is consistent in its approach.


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