The RBA has plenty more to do

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I am very late to the December meeting debate, save for my observation following the Nov meeting (which i got wrong by calling a cut) that the RBA’s story had not changed.

If anything, their problem — well our economic problem — looks worse after the last week of data.

It now looks like mining investment as a share of GDP will peak nearer to 7%, which is a 100bps drop from expectations following the Q4 SOMP, and a 200bps drop from expectations earlier in the year. Sure, half of this is imports, but that’s 100bps of GDP that something has to replace, and it’s not clear what that something is going to be.

In the NAB business and ABS Capex surveys the non-mining sector remains characterised by low confidence and excess capacity. You’d expect, low confidence and excess capacity is associated with a disinclination to invest, and that is what firms are telling the NAB.

The ABS incomes data we have for Q3 shows that firms aren’t making much money (economy-wide profits peaked in Q3’11, and fell another 3% last quarter). So while their debt and equity cost of capital has been falling, their return on capital has also been falling — which means it’s not clear that policy is all that stimulatory.

The partial data we have for Q4 suggests that things are slowing further. Retail sales for October were flat, the 6mma AR has slowed back to ~3.5%y/y pace, and once food is taken out (where price effects may be inflating nominal values) retail sales growth is a meagre ~1.5% AR (again, i use the 6mma).

Credit growth is flattening out once again, with housing remaining depressed, business pulling back, and personal credit picking up — this fits neatly with the low business confidence data we have seen (so firms do not borrow) and the weakness in hours worked (which will tend to cause a short term increase in credit usage, as folks smooth down to their new lower level of income).

Finally, the few bits of data we have for November suggest ongoing weakness. There has been a further decline in all of the measures of job ads (SEEK online ads, the DEWR govt count once you adjust for the day-count, and the ANZ measures), and the AIG Manu PMI fell back to 43.6pts, making for the 9th month of contraction of the sector. This suggests further weakness in the — already weak — NAB business survey for November.

So when the RBA meets today, I would think that the only thing stopping them from cutting by 50bps would be their inflation fears — which i think are misplaced. The wages data has helped a bit with those fears, and the 0.5%qq core print i expect for Q4 should help some more.

If they cut by 50bps, floating rate mortgages are likely to see 35bps to 40bps of reduction, so it’d be a cut and a half ahead of a two month break. Unlikely, but a better call than 0bps, as the economy clearly needs support.

I do think the RBA (well, at least the staff) seem uncomfortable with the inflation outlook — that’s what the Q4 SOMP was all about — so a 50bps cut seems unlikely, but given the economic weakness those fears must have abated somewhat.

Finally, i don’t make anything much of the McCrann “That’s all Folks” article that’s floating about — i tried to find a link, but was unable. A key reason is that he published an article with the same name following the 2011 November RBA meeting, and of course the RBA cut another 25bps at the very next (December 2011) meeting.

Terry may well be correct — it could be the RBA’s last cut — but i doubt it. When job ads stabilise, business surveys get back toward average levels, and the uptrend in the unemployment rate flattens out, the easing cycle will be over. Right now, the mining investment boom hasn’t even rolled over … it’s much to soon to be calling the end of the easing cycle.

I am sticking to my view that the cash rate ends up around 2% — which will put mortgages around 5%


  1. Before I agree with you AGAIN ( come on I need to disagree at some time!!) can I just reiterate ever since Glenn became Governor all RBA staff tell Journalists the same information they tell anyone else and which is public through speeches etc.

    The Economy is slowing for a variety of reasons. Inflation as we saw yesterday is non-existent, wages are okay and will slow.

    Interest rates have to fall.

    I think the RBA are a bit behind the curve.

    Remember it is easier to curb inflation than to reduce output gaps.

    1. I agree, i think they are behind the curve also. Job ads are worrying and if they wait until unemployment is 6% confidence will be shot and they will have to go even lower.

  2. Agreed, I think they’ll do 25bps… and release very dovish minutes. Employment data later on this week is much more important really…..

    Regarding mortgages at 5%, the 3-year fixed are almost already there for most banks. Fixed rates are lower than variable, anticipating further rate cuts. If I am not mistaken fixed rates are at the lowest level since 1990, so conditions are already very stimulatory for housing. I do not think cutting rates will motivate new entrants in housing, or stimulate upgraders. Cutting rates will just help people repaying their debts faster, help with forced sales… but will also hit savers who will reduce their spending proportionally. Govt could increase spending, but they do not seem likely.The real benefits of cutting rates could be felt in shares, and that could be quite important since asset prices have been stable or falling in the last few years. However the real drag on the economy and the most powerful, monolithic deflationary force remains the same: AUD! Only a recession can take that down! Maybe it’s going to be the AUD recession we had to have…. cheers

      1. Absolutely! :) And more and more convinced about it. The short AUD part is stable, but long shares is doing pretty well, especially when including fully franked dividends (by the way, I am not using derivatives, I hold ETF for AUD shares and USD and EUR in bank accounts). For me ASX200 / AUD destiny is to go up and short AUD has potential. In case of a major crisis they would both fall significantly, but AUD would fall faster IMO.

  3. Not on the website — but …

    That’s all, folks
    Terry McCrann

    THE Reserve Bank will all-but certainly cut its official interest rate by 25 points today.
    It will also, very significantly, indicate that’s more or less `it’.
    That it will take some major deterioration in either the global or local economy to prompt any further cuts.
    This would be a major change from all its recent statements — where, whether cutting or not, it has pointed to the likelihood of further cuts.
    Part of the reason for this is that we are beginning to get to the point that cuts in the official rate turn into a lose-lose situation.
    We’ll see a bit of that after today, when the 25-point official cut could translate into cuts of as little as 15 points in actual bank lending rates. So borrowers get reduced benefit. But savers feel the pain more directly, with deposit rates — subject to competition — falling more likely 20-25 points.
    In short, both savers and borrowers get burned. And it would get only worse the closer the official rate got to the zero which applies in most of the major countries.
    It’s not a bank rip-off, but a simple matter of arithmetic — made more punitive for both borrower and depositor, incidentally, by tougher rules to force banks to have more capital.
    The margin between lending and deposit rates has to cover all the costs of running a bank, the inevitable losses on loans, and generate some return for shareholders.
    That return is now a lot lower than it was before the GFC.

  4. Needless to say, I also agree. The RBA seems adrift at the moment: mixed messages, questionable framework. Stevens’ first mistake was the “Glass Half Full” speech in June, in which he told people they should get used to 3-4% nominal growth and that the rate cuts given to date were to help them repay debt, not to borrow and spend. The RBA’s second mistake was not cutting on Cup Day. Again, this gave the message that rising unemployment was fine and inflation was a concern. People will only invest when the RBA actively and verbally supports an increase in nominal growth back up to 5-6%. Then all this talk about monetary policy being ineffective and rates already being low and house prices being too high, etc, will disappear very quickly.

    1. Rajat, nominal growth back up to 5-6% is not in their hands…. it all depends on China, EU, US, the AUD and other international factors. What do you think would happen if we keep getting high inflation numbers and keep the high currency while the rest of the world is experiencing deflation? Are we competitive on the world scale? Large parts of EU are in recession. Do you think a very small economy like Australia can decouple itself from the world economy? We had it good for a few years after the GFC (thanks to China not the RBA). We are still a very small part of the world economy. Lower the cash rate to zero tomorrow and you get an immediate boost, followed by a bust. The gravity is pulling us back to earth, where the world economy is.

  5. We did decouple during the Asian Crisis, the tech wreck and the GFC. It’s hard, but it can be done. NGDP growth is always in the hands of the central bank, but they can’t control the split between real and nominal. The flexible inflation-targeting regime we have should be used to allow higher inflation when the real economy is weak (like now), rather than when it is strong (like 2007/08) because people make decisions based on nominal variables (wages and profits), not real. This seems to be the point the current RBA has not grasped.

  6. Two points:

    – We decoupled during the GFC thanks to China and the increased govt spending not the RBA. We have now the same level of rates but the effects on the economy are not felt in the same way.
    – RBA has allowed high inflation and absurd asset appreciation(shares + housing) pre-GFC, we now pay for it.

    Are we currently competitive on the world scale for anything but mining (even mining are complaining about high wages and costs)? Wages are still growing > 3% p.a. while profits are collapsing.

      1. This data is worrying – makes me sure i would vote for 50bps. Not your view i know, but mine. If nothing else lower debt servicing costs will speed the day where policy bites.

  7. The latest data show wages are flat. Sure, rates at a certain level will provide greater stimulus if fiscal policy is also expansionary, no dispute there. My point is that housing must replace mining in 2013 if we are not to join the rest of the developed world in recession. And for that, we need much lower rates. As for “competitiveness”, who cares? Stephen Kirchner yesterday tweeted a link to a Milton Friedman clip about why imports are good. Exports are what we give up (the cost) of getting what we want (imports). If the AUD stays strong, then who cares if we run a trade deficit while our economy keeps growing? That’s pre-Pitchford thinking. I like re-reading The End of Certainty by Paul Kelly. The CAD phobia in the 1980s was pervasive and what good did it do for us?

    1. Problem with housing is that new houses are too expensive, and they depreciate instead of appreciating, the opposite of why people buy houses (capital appreciation, negative gearing, with yield at 4%). 3-years fixed rates at record low (~5%) and new home sales are still going no where…. that’s all thanks to too much housing inflation in the last decade.

      Regarding “competitiveness”: you say who cares if we run a trade deficit while our economy keeps growing… yes, who cares…. while our economy keeps growing… and who cared in the US about house prices, while house prices kept growing.

  8. I was checking fixed mortgage rates in the UK and found some at Barclays:

    5-year fixed rates are not significantly cheaper than our fixed rates, already (see CBA below), while their national benchmark interest rate is already at 0.50%

    To me that shows that further rate cuts will mainly go into increased bank margins and bank share prices, rather than housing demand per se.

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