RBA relaxed on the economy – rate cuts coming but cup day might be an outsider

October 25, 2011

RBA and Interest Rates

RBA Deputy Governor Ric Battellino delivered a speech today that I reckon was more hopefully than many would have expected. Certainly I saw the usual adherence to a central tendency (mining and developed world growth) with an assessment of the risks around this central tendancy (weak global growth impacting on Australian economic outcomes) but I did not see and overwhelming rush to cut next week. Rather I saw a balanced assesment of what’s been going on recently and the recognition that data in the US and Australia has not been as poor as many feared of late.

In summary, while the CPI outcome tomorrow is still very important to the ability to cut the overall backdrop has improved so there isn’t really a rush.

Here are a few important excerpts – my emphasis and my comments below the quotes

Global Growth

While the forecast for overall growth for the world economy in 2011 was reduced to 4 per cent, that figure is still a healthy outcome. It is broadly in line with trend. The disparate outcomes between the advanced economies and the emerging economies, however, mean that the growth is very unbalanced and there is a sense that the forecast is fragile because of possible severe downside risks.

While forecasts have been revised down since the recent period of financial volatility, the run of actual economic data that has become available over that period, at least for countries outside Europe, has generally been better than might have been expected. This is particularly the case in the United States. It seems that, before the onset of the financial volatility, the US economy was starting to recover from the first half slowdown and that, so far at least, despite the fall in confidence, real economic activity has held up. Recently, analysts have been revising up their estimates of annualised US GDP growth for the third quarter, and the consensus is now for a figure of around 2½–3 per cent.

 The RBA is really saying things are not that bad on balance and growth is in line with trend and ACTUALLY economic data is also printing ok. this is the point I have been making more and more recently and I noted again in this morning’s piece on Chinese equities which was really just about data in the end.

Asian growth

Japan also seems to be continuing to recover gradually from the economic effects of the earthquake.

Elsewhere in Asia, recent data have been mixed, though broadly consistent with the modest slowdown that authorities in the region have been trying to achieve in order to contain inflationary pressures. India perhaps has been the country pursuing this approach most vigorously, and seems to be the country where growth has slowed most noticeably. Overall, however, growth in the region remains solid. Growth in Chinese GDP over the year to the September quarter was 9.1 per cent, and recent monthly data for retail sales and industrial production have been robust. The latest data available to the Bank on shipments of Australian coal and iron ore to China (these are up to September) suggest that shipments have held up, though the weakening in iron ore prices over the past couple of weeks may be pointing to some softening ahead.

Soft landing looks like it is the mostly probable outcome to the RBA I’d say.

 Australian Growth

As the Bank has pointed out before, in recent years there has been a structural change in household spending and financing in Australia.[1] After a 10–15 year period during which households increased their gearing and reduced their rate of saving, they have returned to a more conservative, and traditional, pattern of financial behaviour. Household credit growth has slowed to a rate in keeping with, or slightly below, the growth in household incomes;  the saving rate has increased to a level that is more normal based on history;  and household spending growth has slowed from a rate that substantially exceeded household income growth, to one that, over the past year, has been broadly in line with income growth. Within total consumer spending, there appears to have been a shift away from spending on goods in stores to spending on services, particularly services such as overseas travel, eating out and entertainment. As a result, retail sales have been particularly weak.

This is important because the RBA is telling us that this is a structural shift that is not going to change anytime soon. So the risk of a spending break out is low which of course lowers the risk of getting an adverse outcome from a rate cut. that’s the good news. The other good news is that once saving finds its level, and the RBA says its “more normal based on history” then spending will grow in line with income growth.

So unlike the USA where incomes have gone backwards recently for the hoi polloi, even as top salaries remain in the stratasphere, Australia’s fairer work/remuneration environment means that spewnding can start to increase in line with incomes over the years ahead. T

This adjustment in consumer behaviour has created a difficult trading environment for some businesses, coming as it has after a prolonged boom. But the adjustment in Australia has been benign compared with the adjustments in household finances and housing markets elsewhere in the world, and it has put household spending and financing on a more sustainable path. This will ultimately benefit the health of the economy.

The other other good news is that this balance sheet repair is good for the economy as a whole as we rebuild our balance sheets, good for the banking system as more funding is domestically sourced from deposits and on balance just good all round. Not good for many local retailers most unfortunately but a stronger, healthier economy in the long run.

Total final demand grew by 3.4 per cent over the year to June, which is about in line with past trends. That, however, has not translated to trend growth in GDP, as the high exchange rate and the high import content of some mining investment have seen an increased proportion of demand being met from imports, rather than domestic production. The weather-related disruptions to coal exports added to the shortfall in production. In this environment, employment growth slowed noticeably in the first half of the year, and around the middle of the year there was some rise in unemployment.

Even though the RBA likes the structural change anad its impact on household and economy wide balance sheets it is still a mite concerned about the impact of the high Australian Dollar and its impact on dragging import volumes up and away from domestic produced or sold goods. I think its genuinely concerned about the unemployment even if it is essentially a throw away at the end of that paragraph.

…inflationary pressures, which had declined through 2010, appeared to pick up noticeably in the first half of 2011 and the prospects were that inflation would rise to above the target range of 2–3 per cent over the next couple of years. That created a difficult environment for monetary policy. As the Bank noted after the October Board meeting, however, the downward revisions to recent estimates of underlying inflation and the softer global economic outlook have made the outlook for inflation less concerning, providing scope for monetary policy to be supportive of economic activity, if needed. Tomorrow’s CPI data will provide further information in this regard.

Here is the smoking gun for interest rates. The RBA and the market was overly fixated on the mining boom, phillips curve, unemployment at or around 5% and the expected impact in driving inflation higher. That has not happened and increasingly is less likely too so as soon as the CPI prints toward the lower end of the 2-3% band the RBA has cover to cut “IF NEEDED”

And perhaps they dont thing it is needed just yet because this is consistent rhetoric over the past month and the RBA notes as well that Home Loan rates are lower already to a certain extent even without the need for them to move.

Recently, there has been some easing in financial conditions following the fall in market interest rates that has accompanied the financial volatility. Banks have passed through to borrowers notable declines in interest rates on term housing loans and some business loans, as their cost of funds has declined. Increased competition among banks in response to the increased availability of deposits and relatively subdued demand for loans, has also resulted in some shaving of interest rates on standard variable mortgage loans for new borrowers. As a result, the interest rates on new loans are now around 10–15 basis points lower than they were early in the year. The modest net fall in the exchange rate in recent months has also, to some extent, reduced pressures on some sectors of the economy.

I dont want to over or under play this fact but according to the RBA monetary conditions have already eased. that WILL be factored into their thinking. They also noted that recent Australian data has not been as weak as might have been expected which I agree with and they note that housing Finance might be on the up – certainly the lead lag relationship with motor vehicles suggests to us that might be so.

Summing up

Overall, while it is possible that the global economic situation might take a sharp turn for the worse, at this stage the Bank’s central scenario is that global GDP growth will be broadly in line with its long-run average over the period ahead. That would create a reasonably benign environment for the Australian economy. The global situation remains fragile, however, and will require careful monitoring.

All in all I think this a very good speech. now readers know I have been calling for RBA cuts for some months now and took great exception to the calls for rate hikes just a few short months ago. This remains the case. But the RBA is suggesting that while the time is coming for some rate cuts in Australia they don’t believe that the markets pricing of 160 bps a few weeks ago, or even 100 bps for the next 12 months, today is appropriate.

Rate cuts are on their way and a low CPI tomorrow increases the chances of a Melbourne Cup cut but it is no certainty.

Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, 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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  1. Cut Cut Cut…no more excuses | Lighthouse Securities - October 26, 2011

    […] Given it will be cup day the easy answer is to have a bob each way and say they should but I dont think they will because they are yet to be convinced of the need. This was writ large in  Ric Battellino’s speech yesterday and covered more broadly by me yesterday. […]

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