The RBA — more relaxed than i expected

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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.


  1. An interesting question/answer we recently discussed on this blog is this one:

    AFR: As you know every pet shop galah that comes to Australia says our housing prices are too high and that may be arguable. But if you’re thinking about perhaps cash rates below 3 per cent, given that household leverage has only levelled off, are we at all vulnerable?

    Stevens: My position as you know on the level of housing prices has been they are high.

    [SSEC: still they need to go higher????]

    I think that when you put it fully into international perspective – that is, don’t just compare with the US, compare with a whole range of countries – it’s actually a lot harder to make the case that they’re grossly overpriced and due for a crash. After all, we’ve been around this level of house prices/income for 10 years – [it’s] taking a long time to burst if it is a bubble.

    [SSEC: this is wrong. See the comparison median house prices RPData and median income Census 2011:
    Maybe RBA are using different metrics, but the census household income is hard data and RPData is based on real transactions too.]

    So I’m not so much concerned about a crash, but as I have said also before, it’s seems to me we would be flirting with danger were we to see a very big run-up from these present levels.
    Now, we have seen some gain in house prices over the past year or so that’s reversing a little bit of an earlier decline.

    [SSEC: this is wrong, again. House prices are completely flat y/y and q/q too.
    Some capitals up, some down]

    That doesn’t trouble me, I think that’s probably part of [the] cyclical transmission mechanism working.
    But it would be, I think, troubling if you saw a return to very strong 10 to 20 per cent per year persistent rates of growth of housing prices, especially if that was accompanied by a return of rising leverage.
    I think that would be a very dangerous thing to do and we would be imprudent in the extreme to preside over that.
    I don’t think that’s what’s going to happen by the way – I don’t think that is what is happening and I don’t think it’s that likely because I think the household sector has worked out.

    1. I think the idea of 10-20% pa persistent growth rates in dwelling prices is a straw man – no one is suggesting that is necessary or desirable (or possible). But I think he is kidding himself if he thinks that the RBA can stimulate housing investment without a year or so of double-digit increases, which incidentally would barely get many properties back to where they were in early 2010. When asset markets move, they don’t move in 5% pa increments! I think if China doesn’t recover strongly next year, we will be in a similar place to where we are now, but with a 2% cash rate. That probably won’t help Gillard.

    2. I think the RPData median house prices over census median income is really great info.
      You can see from the table, that the current two best markets (Sydney and Perth), actually had a decline of this ratio between 2006 and 2011 and so now they seem to be recovering some of the ground lost. They are the healthier markets currently. On the opposite, Melbourne and Adelaide are very stretched and indeed prices are currently coming down there. Brisbane seems to have potential. If we assume 6.5 is the top ratio for this measure, we can forecast *established* house prices to be flat to 3% up y/y, I do not know if that is enough to spark a residential construction recovery… were we buying just because house prices double every 10 years?

      More from the interview:

      AFR: Does that mean we’re one recession away from disaster?

      Stevens says: “Well I’m not saying we want to lift the mean level of house prices to some high level in order to get cyclical recovery of construction – that’s not the way to go.
      What I am saying is that some gentle reversal of a 10 or 15 per cent decline we’ve had, that’s okay, you know, that’s still stable and fluctuating around a given mean. So, I don’t want to go to the premise of that question because I don’t accept it.”

      AFR: Okay but does it still mean that if our prices are rather high, that we’re one recession away from some kind of disaster?

      Stevens: Well, how would such a disaster unfold?

      Usually people worry about the banking system coming under stress. (AFR: Unemployment and the banking system)

      This is precisely what the various stress tests, including the one’s the IMF have previously spoken of and precisely what they simulate – they’re only theoretical exercises, they’re not the real thing – but those exercises are basically persistently done a few times now and have come up with the answer that the banking system would suffer a certain degree of losses but the banks would remain solvent.

      Probably the worst that would happen is that they might need to get a bit of capital to make sure they remain above regulatory minimums but they don’t even go close to being insolvent, so I think a big asset price downturn usually does amplify whatever other downturn you’ve got, but we’re in as good a position as you could hope to be in to accommodate if that ever did occur and it does not seem to be occurring at the moment.

      [SSEC: answer is a bit vague IMO]

  2. Thanks for the post and the link. Stevens certainly seems quite relaxed. Still happy to allow the cash rate to keep inching down, but not keen for it to get to zero. Indicates he would like a bit more housing investment and some price rises but would prefer more manufacturing capex, probably to avoid an “asset credit build up that then gets you into trouble later”.

  3. I think by February we will know whether RA or the RBA is correct.

    My view is that rates will be cut further.

    I see very little on the landscape to believe the economy is suddenly going to speed up if anything it is the opposite.

    1. Do you think low inflation will be enough? Bass in today’s AFR seems to think they will need to see more demand side stuff.

  4. It seems to me they will know by the next meeting courtesy of partial indicators whether they are correct or not.

    As I said I believe they are not BUT I am not dogmatic about it.

  5. If financial markets keep going, the us cliff thing is resolved positively, and iron ore keeps at these levels, I think no cut in Feb. While house prices were flat in 2012, the ASX 200 was up about 15%.
    On the other hand, if we get a correction in shares between now and FEB meeting, a very very low inflation number or a disappointing job number, then a cut is back on the agenda. Basically if things stay as they are, no cut for the time being IMO.

    Merry Christmas!

  6. It seems as though Swanny has finally bowed to reality. ( He was quite impressive at the press conference. )
    He won’t try and slow the automatic stabilisers.

    I think this means an interest rate cut is more likely

    1. He is going to have to find some savings if he wants to project a surplus in 2013-14, and i think he will want to — which is why i think that this means a cut is more likely. Maybe my thinking is twisted, but i figure they must keep cutting to get something they can take to the election.

      1. Why bother? Especially when the RBA shows no real urgency to help fill the gap. And who would believe them anyway? Whatever people say about the economics of a deficit, politically it will undermine any Labor attack on any Coalition ‘black hole’. This is starting to look more and more like 1996.

  7. Maaate,

    If you keep cutting to get a ‘surplus’ you will end up with a deficit.

    Cutting spending or raising taxes will depress nominal GDP further. surely the European example has not been forgotten so soon.

    This announcement may have the bonus of bringing the exchange rate down to levels it should be given commodity prices.

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