Prior to the RBA’s 4 December meeting, I figured that a 50bps cut was a higher probability than a 25bps cut. The minutes to the December RBA meeting show that I was mistaken.
At this meeting, the information on labour costs and softening labour market conditions suggested that the inflation outlook still afforded the Board some scope to provide additional support to demand. Further confirmation that the peak in resource sector investment was near, and that the short-term outlook for non-resource investment remained subdued, indicated that there was a case for the Board to provide that support. The Board considered whether to respond to this case in the near term or wait for further information. On balance, members saw merit in reducing the cash rate at this meeting.
The RBA probably always considers a few options, but it doesn’t always say that they considered waiting for more information when they cut. On that basis, I judge that they decided to cut 25bps to 3% in a pretty close call. That is to say that the argument for a 0bps move was considered to be of similar merit to the argument for a 25bps cut.
There are a couple of questions that come to my mind here.
The first is to ask: what reassuring things does the RBA see that I am missing?
The minutes here are fairly explicit — they see the Chinese and US data as having improved, and judge that this more that counters the weakness in Japan and Europe.
I am more pessimistic. If we get through 2013 with both the EU and Japan in recession, and the US not in recession, it’ll be a rare event. It would also be rare for the US to go into recession given the uptick in the house-building sector. The upshot of these two historical regularities is that the US is unlikely to return to anything much better than 2% real growth in next year. That makes it hard to see China doing much more than 7%
The RBA also sees some signs of health in financial markets. Here I agree, however it’s worth nothing that the credit ratings agency ‘war on wholesale funding’ is severely constraining the ability of the Australian Banking sector to pass on the benefit of that improvement in terms of lower rates. Of course, corporates are able to access wholesale funding on better terms, and this helps, but it’s slower and less direct than easier credit markets lowering retail deposit and mortgage rates, as occurred a decade ago.
The second is: why does the RBA judge that the economy is around trend?
Here things are less clear. The RBA mentions the weakness that liaison is reporting back to them in several places — weak investment, weak hiring, low wages growth — but they retain the view that the economy is around trend. With real GDP growth around 3%, the unemployment stable at ~5.25%, and the employment to population ratio steady at ~61.75% for two quarters, there are sure reasons that support this view in the hard data — but what about all that softer data?
The bridge between the weak business surveys (including RBA liaison) and the robust real sector data, seems likely to be weakness on the nominal side of the economy. The decline in the terms of trade is reducing real incomes, and this is making the operating environment tougher for firms.
As far as I can tell, the business surveys probably measure real Gross Domestic Income (it’s not considered in this RBA bulletin, however you can see that Real GDI has a good match given the similarly good relationship between real GDP and nominal GDP). This makes sense — firms operate in the nominal world.
It remains to be seen if firms shed staff in an attempt to re-build margins, or if they find productivity gains that lower real unit wage costs — however, what is sure is that if the terms of trade go back to average, the two lines in the above chart will converge. My guess is that the transition will involve less employment, and low inflation — which is why I see scope for plenty more rate cuts (down to ~2%).
I guess that this is the largest difference between the RBA’s view and my own: I expect to see rising unemployment, and weak inflation. They say that it’s needed:
For inflation to remain contained, ongoing productivity growth and a further sustained moderation in wage growth would be needed. Recent data indicated that, to date, there had been a small decline in the growth of wages, which was consistent with the softening in the labour market seen over the past year. The forward-looking labour market indicators had generally declined recently, suggesting that employment growth would remain modest in the months ahead.
Though I suppose that actions speak louder than words, and that they have already been cutting — so perhaps they do share some of my sentiments with regard to how these two lines (real GDI and real GDP per hour worked) are likely to evolve, and what their likely evolution might mean for unemployment, inflation and monetary policy.