RBA cuts on global growth

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The RBA lowered their target for the overnight cash rate by 25bps to 3.25%, effective 3 October 2012. Their statement pitched the cut as due to the weakening global growth outlook. However, there is much more to this statement than backward-looking explanation — it breaks new ground in many places, and sets the stage for a few more cuts.

The important new bits were an assessment that the labour market was softening (notwithstanding the 5.1% unemployment rate) an acknowledgement that the mining boom is both flagging and likely to peak at a lower level than had been previously expected, a clear statement of the importance of an acceleration in the non-mining private sector to offset this, and recognition that ‘below average’ rates may not be ‘below neutral’.

The immediate driver of the cut was the global growth downgrade. This reduced growth assessment seems to follow the recent IMF downgrade, increased uncertainty about the Chinese outlook, and the recent downgrade to US Q2 GDP. It is somewhat at odds with the partial data for Q3, such as the recently better manufacturing PMI data for September, however that’s an old tension — the Bank has long preferred IMF forecasts and quarterly data.

The commodity price assessment was marked down to ‘significantly lower’.  Lower commodity prices mean a lower return on capital in the mining sector, and reflecting this the mining investment outlook has been lowered. The investment boom is now expected to peak in 2013, at a lower level than previously expected.

Looking ahead, the peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected. As this peak approaches it will be important that the forecast strengthening in some other components of demand starts to occur

As this investment boom recedes something must replace it — else we will have a recession. That’s the reason the RBA has to keep cutting — the interest rate sensitive sectors will be harder to boost if the RBA waits until confidence is low, as by that time expected returns will be lower, so a  still-lower cash rate will be required to make investment attractive on a risk-adjusted basis.

All this is somewhat at odds with the 5.1% unemployment rate, and the RBA dealt with this ‘issue’ by dismissing it:

The Bank’s assessment, though, is that the labour market has generally softened somewhat in recent months

With a weaker global growth outlook, and a softening labour market, it comes as no surprise that the inflation outlook remained ‘consistent with the target over the next one to two years’, despite the lower path for the cash rate.

The financial conditions paragraph showed further separation between ‘below average’ and ‘below neutral’. The bank observed that rates have been below average for some time, but noted that we have seen only tentative signs that policy is stimulatory (though of course lags are long and variable). If monetary policy does anything it is to set the price of credit, and credit growth has been both weak and weakening — so it’s hard to argue that money is too cheap.

I am convinced that neutral is falling, due to both structural changes in banking, as well as lower expected returns. If you assume that expected returns on investments have declined, you can neatly explain the higher savings rate (more saving is needed to hit retirement goals, and investments are less attractive than 5% government guaranteed deposits) without the need for hocus-pocus about visits from the offshore confidence fairy.

Lower expected returns, and declining domestic profitability, make it hard to see the non-mining private sector stepping up to fill the investment hole left by the mining sector.

My best guess remains that the RBA will cut again, to 3%, at their November meeting — and will retain an ongoing bias to ease further. Though, of course, i’ll update this view as the meeting draws nearer.


p.s.  This meeting marks a perfect year for Ricardian Ambivalence RBA calls. Thanks are due to those who contribute to the discussion in our comments.  The discussions are good, and they improve the brew — this lucky year owes as much to the comments as it does to good luck (or any of the other factors).  Hopefully I haven’t just jinxed us!


  1. Best analysis I’ve read so far. Agree 100% there is nothing to fill the void sans resources.

  2. Well done on your “perfect year”!

    I am also happy with my “ASX200 over AUD” long trade (long ASX200 and short AUD trade) that is playing out quite well. Up 10% since beginning of the year and never gone into negative territory with minimal volatility :) :) :)


    1. that’s a good trade … and positive carry too, as div yields are larger than the yield gap between AUD and USD. when do you take profit?

      1. I think this is a trade that I will keep going for a while. I started building it in August last year, during the “big panic” sell-off, and I have been being building on it for a while. With the ASX 200 still only back at 2005 levels and the AUD still very high (relative to commodities now too), the potential is still there. Plus, should a major crisis unfold in the US and/or Europe, the AUD would fall significantly, protecting losses in shares (AUD would fall faster IMO in that case) so the overall trade is still OK. The only doubt I have is about the AUD. Probably around 0.90-0.95 (if it gets down there “naturally” due to the Aussie economy and rates cutting, rather than a global panic) I would sell USD, buy AUD and put that money into ASX200. And should not forget AUD is also close to record highs vs EUR too….

  3. are you being frank? i read on september 4 after the september rba meeting you wrote on this blog: “It is possible to see an November cut if everything goes right (or more accurately wrong!). Right now, I have no beef with market pricing for December, though pricing for Oct looks wrong to me.” can you explain why you changed your view from a possible Nov cut and no Oct cut to getting Oct right?

    thank you

  4. RBA calls are much easier these days than in the days years ago.

    I agree the cash rte is going below 3% as well.

  5. I said it before and I will say it again but you only get good comments if the original comment made by you provokes it.

    Yours is a must read blog and this reflects the quality of the work you write here.

    so I agree it has been a very good year for you

    1. Indeed. And for free to boot! The contrast couldn’t be greater with the paid subscription media, which produces drivel like this (I blame Chris Joye).

  6. Excellent work and thanks very much for providing your first-rate analysis for all of us to read

  7. It’s going to be interesting to see if investment outside of mining can balance govt austerity + end of mining boom. Like you think at the moment, that would probably require much lower rates. I reckon the RBA has been cutting rates this year in the hope that earlier cuts will result in fewer cuts needed later on. One thing that I am still not convinced about is all the negatives that we read now about the end of the money boom. As I stated before, I think a lower AUD could provide a significant cushion to the economy. maybe more significant than we think.

  8. I was about to write:

    “You are one of the few commentators I read that doesn’t finish his first sentence post an RBA Board meeting with “which I correctly predicted here [link to previous post]””

    Then I read the “p.s” :P

    But the tone is humble – which is another reason why you have many loyal readers. Thanks for the great work over the years.

    1. The binomial theorem makes a hero of everyone every now and again — and let’s face it, it’s the future we need to predict to add value. I know i’m going to get one wrong before too long … luck has played its part this last year.

      The advantage of good comments / questions is that it keeps you from believing your own b.s. It is very easy to see what you want to see — i think that difficult questions from friendly voices reduce the probability of falling into this trap.

  9. It cuts both ways. A sensible piece enables a person to view whether they are looking at an issue in the right way or not.

    The beauty here is that people can have differing views but can talk to each other.

    1. Perhaps a benefit of a small group. I think as things get very big, that it gets harder – folks become more anonymous and therefore less polite.

  10. Referring to host’s comment:
    “The important new bits were an assessment that the labour market was softening (notwithstanding the 5.1% unemployment rate) …”

    Can anyone cite why the RBA doesn’t seem to have faith in the ABS’ published unemployment rate? I know the RBA and ABS don’t see eye to eye on everything (e.g. GDP estimates), but the labour force survey seems to be one of the ABS’ more trustworthy publications (surveys nearly 30,000 households every single month). The seasonally adjusted (more volatile of trend and seasonally adjusted series; original is useless) unemployment rate has been flucutating between about 4.8% and 5.2% for about the last year. The trend was 5.0% Jan ’12 to June ’12, and 5.1% in July and August ’12 so just barely trending upwards.

    Morevover, the ABS labour force survey follows the International Labour Org’s definitions, concepts, etc. I wonder why the RBA seems to lack faith in the ABS’ publshed figures.

    Source: http://www.ausstats.abs.gov.au/ausstats/meisubs.nsf/0/BBE86DBB6C4A8299CA257A700014B7B3/$File/62020_aug%202012.pdf

    1. Sample size is too small. The monthly numbers are a bit of a joke. The trend is okay, but like all things there is no one single good index for the state of the labour market. In the present case it looks like redundancy is causing the employment to population ratio to trend down but leaving the unemployment rate steady as those who lose their jobs are not immediately looking for work.

  11. Thanks for the answer, and I agree having read it and given it more thought. The question I should have asked is, “why DOES the forex market seem to put so much faith in whatever the monthly unemployment rate is?” Full of risk-taking speculators, I suppose.

    1. i think the FX market gets too much flack. if you zoom out, you can see the BIG macro stories of the last 30yrs in the free floating exchange rates. the problem is that folks put a trade on to buy AUDUSD at 1.02, with a target of 1.04, and a stop at 1.01 — that’s fine if you have flow information, or are trading momentum, but that’s not an economically meaningful move in a currency … it’s just noise.

      to make that thought more obvious, i guess it’s because there are lots of micro trading strategies — and the smart algos know that it’s time to get out if the data goes against them. however, i am not convinced that means the FX market is distorted in a meaningful way.

      take the high AUD — a clear reason to prefer AUD assets is because inflation risk is lower in Australia. We are not conducting QE and have a good fiscal situation. inflation risk is a pretty big deal, so why are we sure that the AUD is ‘rich’ ? it might be high for us, but there’s lots of 50% loss risks out there, and the current state of the AUD is mild compared to the losses that will be suffered if QE creates an inflation breakout.

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