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!