RBA to ease 25bps on 6 November

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In the long run, the only thing that monetary policy can do is set the price level. Pretty much every economist agrees with this if we make the time horizon long enough — so it’s natural that after the high Q3 inflation print some will argue against further easing of monetary policy.

I regard this as a reasonable argument, and if the labour market was tight and demand conditions were firm, i’d probably be making it myself, however i think that the right thing to do is to be confident and cut the official cash rate by 25bps to 3% at the November RBA meeting.

My initial impression was that ex policy induced supply shocks that core inflation was ~0.5%q/q. The publication of the PPI and trade prices, following the Q3 CPI report, makes this judgement a little less speculative.

Headline final goods PPI was a modest +0.6%q/q in Q3 (mkt +1%q/q), to take PPI to 1.1%y/y. Intermediate PPI was 0.1%q/q (1.5%y/y) and preliminary goods PPI was -0.2%q/q (1.2%y/y). So current inflation looks to have been weak, and if anything there’s disinflation in the pipeline.

Consumer goods are what the RBA targets however — that ‘pipeline’ also looks empty. Due to a decline in import prices (the AUD appreciated modestly) consumer goods PPI was a +0.8%q/q (-70bps to 1.0%y/y). Domestic Consumer goods PPI was +1.2%q/q (-70bps to 0.8%y/y) despite this being where the carbon tax boosted utilities sector is located; imported consumer goods PPI was -3.4%q/q (-0.5%y/y), larger than the 2.2% gain the the AUD TWI (2.9% AUDUSD).

All this seems consistent with there being generally low consumer price inflation pressure in Q3, and also generally low inflation risk over the medium term.

Most models show that it takes a few years for falling import prices to fully work their way through the system, so the very low consumer goods PPI import prices in Q3 suggest low inflation risk over the next year or so.

The trade prices series is important because it allows us to pin down the terms of trade. Import prices fell by 2.4%q/q and export prices fell by 6.4%, meaning that the terms of trade probably fell by about 4%q/q in Q3. This takes the decline in the terms of trade, from the peak a year ago to ~14%. This is only a few ppts shy of the decline in the GFC (where the AUD crash protected us from a much larger drop in the USD price of our exports).

This terms of trade decline continues — despite what you might think given the bluster about the spot price of iron ore in the Chinese port of Tianjin. While Iron Ore is an import export, it’s not the only export, and we don’t only deliver it to the Tianjin spot market. Coal is also important, and due to it’s price tanking the RBA’s export price index shows that SDR export prices were -3.5%m/m in October — a rise in the price of Iron Ore exports offset some the decline, but not all of it.

In AUD terms, the price decline was 2.2%m/m (the September price decline was also revised down to -2.2% in SDR terms, and +0.1%m/m in AUD terms, from -1.3%m/m and +0.9% respectively).

Finally, it’s worth noting that it’s not the export price per-se that matters. Central Banks care about export prices because they worry that high profits are a leading indicator of higher inflation (via higher investment demand). We have seen ongoing project cancellations despite the Iron Ore price bounce — so it seems that BHP for one is not buying into the hype. Additionally, Australian Coal mines have been closed.

So on the inflation side, i see weak pipeline (PPI) price pressures, a falling terms of trade, and an ongoing decline in the price of our exports — these factors have historically presaged weak (and weakening) underlying inflation pressures.

The supply shock from policy might be something you’d worry about — due to second round inflation — if the labour market was tight … but it’s not. The unemployment rate is rising, job advertising is very weak (and weakening), and hours worked per employee suggest ample spare capacity even at current levels of employment. Thus, it seems unlikely that the cost of living increases due to government policy changes will lead to second-round inflation.

Finally, the data this past week has put paid to another argument against lower rates — that they are goosing house prices. The October RPdata house price estimate was for a broad based 1%m/m NSA decline in house prices, spread across markets except Perth and Darwin. This index has been volatile, and i think the most accurate thing we can say is that prices are probably stable.

The weakness of housing credit and low level of housing finance applications suggests that whatever strength there is in the housing market is narrow. Owner occupier housing credit was a meek 0.3%m/m in September (a new low of 4.5%y/y), and investor credit for housing was 0.4%m/m (up from the low of 3.2%y/y in 2009).

With prices probably flat (it’s implausible to argue that they are falling at >; 10%y/y, after rising at a slightly faster pace the prior month), and credit weak, it’s tough take arguments that asset price inflation is a reason not to ease monetary policy.

Reliable house price growth is a pre-condition for the residential investment lift that the Treasury and RBA are looking for to keep us out of recession when the mining investment boom turns down in 2013. It’s a pre-condition, as builders and financiers are reluctant to hold risky inventory of properties if prices are falling — which makes them reluctant to invest.

With unemployment rising, inflation low, export prices declining, and the housing market remaining weak, there is both scope to ease policy and a need to do so. Add in a fiscal contraction that is going to crunch even harder in 2013, and it’s plain to see the case for a few more cuts.

I expect that the RBA will make a further adjustment to policy at their 6 November meeting, taking the cash rate down to 3%, and signalling that’s it for the moment. They will probably try and take a break for a while in H1’13 — to gauge how quickly the mining investment boom is likely to tail off, and how housing and residential investment is responding to easier policy.


  1. The problem with housing is that NEW houses and apartments are just too expensive compared to existing ones. It’s not that they are not building them, the problem is that no one is buying them (or not enough). And the reason is not rates. It’s just that they are too expensive, unaffordable and they depreciate fast once bought. Building in Australia has become too expensive.

    Look at this latest release from HIA, particularly the graph of sold vs approvals.


    It all used to work when people were buying off the plan, with easy credit, and with the prospect of easy / automatic gains. But we now seem to be at the peak after a period of aggressive appreciation, so lower rates will not do much for NEW residential construction IMO, as they have not in the last year.

    The plan of lowering rates to stimulate residential construction to fill the void left by the end of the mining boom is a chimera: it’s no vaccine for the dutch disease! The only possible way out is a lower AUD. But a a lower AUD will come only with a recession???

    1. i still think that housing will respond to lower rates. for sure the pace of housing starts is running below what you might have expected given the drop in mortgage rates, so my argument have taken some blows this past year.

      does that mean we just need lower rates? that’s my judgement — but heck i’m arguing for more of the same, and i might be wrong.

  2. ssec, that’s exactly why we need lower rates. We need to reallocate miners and tourism workers into home-building, which will require higher prices, which will require seriously more expansionary policy (not just begrudgingly lower rates).

    1. New houses are completely unaffordable comparing to existing ones, and you want HIGHER prices? We need LOWER prices so that people can actually purchase them. Or we need salaries to increase 10% p.a. and/or credit to grow like it used too (but it will not).

      I hope we will not find out that we have an oversupply of existing houses in Australia all of the sudden (this things tend to happen overnight see Gold Coast) or we are toast.

      We keep pulling forward demand until there’s no demand left. And in the meantime rates are peaking lower on each cycle.

      1. agreed on this — it’s just shifting demand through time. house building is like a optimal control problem — only need about one house per three people, on average. Build too many now, and you won’t build them later. some say we have a shortage as we haven’t built enough these past few years — i am not convinced, but i do think we can bring a little more work forward by lowering rates.

      2. Ricardo, maybe we do have a housing shortage, but then why aren’t we buying what’s currently on the market (and especially the new houses as per document above)? Transactions are at multi-decades low and interest rates are quite low too already.

  3. From a GE perspective – ie if we want to maintain full employment – something else substantial has to ramp up to replace a fading mining investment boom, That could be a different (eg manufacturing) investment boom, an export boom, a housing boom or a retail boom. There’s not much else, so take your pick. With the exchange rate stubbornly high and weak world growth, it’s probably going to have to be housing and/or retail. Yes, houses are expensive by world standards; but so is eating out and using a personal trainer. But those are the sorts of things that will have to grow. The job of monetary policy is to promote the nominal growth in wages and incomes needed to facilitate that reallocation of resources given the prevailing rigidities.
    Incidentally, I don’t think we are on the verge of too many houses. Household size is in secular decline and my understanding is that we haven’t built too many lately.

  4. There’s a Sumner for every occasion. Permit me the indulgence.

    From the Economist:

    The central bank has kept its benchmark interest rate at 1% for two years, encouraging Canadians to pile up debt, particularly in mortgages. In Toronto house prices have risen by 8.3% in the past year. Mark Carney, the bank’s governor, has issued repeated warnings about these growing liabilities. Consumers’ ability to borrow and spend may be nearing its limit… The government is doing its best to talk firms into investing. Mr Carney has demanded they start spending their “dead money”, which earns little interest thanks to his low rates. “Their job is to put money to work,” he said recently

    Sumner’s response:

    Mr. Carney is wrong. It’s the central bank’s job to put money to work, i.e. to control total spending (M*V). Once the central bank provides the optimal amount of NGDP, the labor market will return to equilibrium and Say’s Law will apply. Countries are never actually held back by the public’s ability to borrow and spend, but rather by the public’s ability to work and produce. A country may be temporarily held back by the public’s desire to spend, but that’s a failure of monetary policy, not the public. The central bank determines the total level of spending. No society can ever run out of the ability to manufacture more spending, unless the central bank runs out of paper and ink.

    1. i do love sumner — he focuses my mind on the importance of expectations. What’s always left hanging for me, however, is just how the central bank lifts inflation expectations, and what the long term consequences of lifting them might be.

      I guess Carney is worried that the rise in inflation now might mean lower inflation later — if asset prices overshoot and then correct, as occurred in the USA. Sumner wold argue for still more NDGP to make the old expectations / investments pay off. I worry about how scalable this ‘solution’ might be — eventually we hit something like a vertical phillips curve.

      1. I guess if house prices overshoot and then correct, stable NGDP growth implies that something else will pick up the slack. If trend GDP growth is slowing due to slowing population and productivity growth, then most NGDP growth will be inflation. But I think we are a long way from that in both the US and Oz.

      2. ” If trend GDP growth is slowing due to slowing population and productivity growth, then most NGDP growth will be inflation”

        No growth and high inflation? Sounds more like a war scenario I would not inflict to any society.

        “ie if we want to maintain full employment – something else substantial has to ramp up to replace a fading mining investment boom, That could be a different (eg manufacturing) investment boom, an export boom, a housing boom or a retail boom.”

        What about no boom. Instead a pause for reflection.

        I’ve been trying to learn more about NDGP targeting recently but it feels to me like Marxism: perfect on books but impracticable in the real world. There’s always some little details that escape the theory.

      3. If trend real GDP growth is slowing, there’s a job for microeconomic reform. All the central bank can do is maintain stable NGDP growth to allow for real growth to arise where it can. Allowing NGDP growth to fall in line with lower trend RGDP growth will simply make recessions more frequent because the ongoing reallocation of resources required to maintain that slower rate of real growth will become harder to achieve due to downward nominal wage stickiness. I’m not saying we should have double-digit NGDP growth like the ’70s, but perhaps 5-6% in the Australian context. This is lower than average NGDP growth over the last decade. It’s only been in the last 2 years that the RBA has allowed NGDP growth to fall to 3-4% – god knows why.

        As for a ‘pause for reflection’, do you mean ‘recession’? The mining boom is fading, unemployment is rising, so without something else to take over, we will have a recession. What’s the point of that? A recession never put any economy on a more sustainable footing.

      4. So if Australian GDP growth falls to 1% for instance we should have 4-5% percent CPI inflation according to the NGDP theory? It wouldn’t work. Too much inflation is just bad. Look our salaries are already growing at 4%, non-tradable inflation too, and we will be soon paying the price of that (part of the reason why building a new house in now so expensive compared to existing ones) We are not living in a vacuum. At once, our salaries are now very uncompetitive on a world scale. That’s OK during the biggest mining boom in a generation, but when that’s gone, what’s going to replace it. In your theory we should have had higher non-tradable (mostly domestic) inflation? 5-6%? That’s a recipe for disaster in a world around us that is hardly growing.

        “A recession never put any economy on a more sustainable footing.”

        Slowing down is a part of the cycle and recessions are sometimes part of slowing down and necessary for re-balancing.

  5. Ricardo, good to see you back. I think they will cut and my best guess is Nov – particularly if partial aim is to keep housing afloat. Trouble is I can’t quite see how that will work out. Seems to me peak household debt combined with economic uncertainties (reports of job losses, mining boom ending, EU etc) will curb a rush to housing. The very idea that housing can substitute for the boom is questionable – it may pick up some employment slack but will not replace FDI or ToT significance.

    ssec – I’m with Bloxham, dutch disease is largely a myth as far as Australia is concerned (and in any case the Dutch recovered)! If we go pear-shaped post mining-boom we discover will are little different to other developed economies that flourished during the global credit boom and struggled post. Resources or not.

      1. Now that’s a swings and roundabouts thought! Chris Joye notes Phil Lowe saying “[T]he currency is still not at the point where I think you can make a strong conclusion that is fundamentally overvalued, particularly given the considerations that I was talking about.”

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