The RBA’s Q1 SOMP is an odd document. It is odd for two reasons: it breaks my policy rule of thumb (the RBA moves rates when they move their forecasts), and it contains an odd tension between optimism and reporting on the data — so much so that it might have been written by completely different authors.
For basically the entire time I have been watching the RBA, they have been a fairly plain-speaking central bank. Perhaps due to the luxury of a floating rate mortgage market, the RBA has simply told it straight and moved rates when the world changed.
This seems to have changed in the Q1 SOMP — the RBA lowered both their growth and inflation forecasts, but they did not move their policy rate at the proximate meeting (in this case February 2013).
As a result, we are now in an unusual place: the RBA forecasts below trend growth and sub-target inflation for most of the projection period. Admittedly, these are not very large ‘misses’ just now — however given the weakness of many current indicators and the ever-present downside risks to the forecast, I am surprised that the RBA is happy to run with the risk of sub 2% inflation exceeding the risk of over 3% inflation.
Indeed, due to the fact that growth is sub-trend, we actually see inflation trending down slightly across the projection period.
The RBA sees all the risks i see — but they don’t worry about them like i do … the difficult question is: why?
Liaison has told them that the increase in the Iron Ore price is not flowing through to activity:
The sharp increase in the price of iron ore in recent months does not appear to have materially affected investment plans to date, in part because the general expectation is that prices will not be sustained at these levels.
They see the broad based weakening of business conditions, and the decline in both mining and non-mining investment intentions …
They see the recessionary state of labour demand …
They can see that odd movements in the participation rate are hiding the slack in the labour market …
And they can see residential investment is struggling to gain traction despite 175bps of rate cuts …
But still they do not sound all that dovish on rates … Why?
The answer seems to be rising house prices …
House prices are going up, and what we know from experience is that rising house prices tend to boost short term demand (of course, they also may create other problems down the track — which perhaps the RBA would also like to avoid).
Rising house prices tend to boost consumption via a wealth effect. Also, as the expected cost of carrying development inventory declines, rising house prices also tend to boost housing investment.
These are two of the elements of demand that have been weak for some time, and it seems that the RBA has decided to pause for a moment to see if this is a turning point for these sources of demand or if they will remain weak.
This still leaves the question of timing unanswered — the same trends were fairly clear in Q4, so why cut in October and December?
Here I have a less satisfying answer — there are hints of a material change in external demand in the Q4 export data, and the prospective improvement in external demand gives the RBA time to see if the easing they have delivered to date will continue to work its way through the financial space, and also to gauge the extent to which higher financial wealth might eventually seep into higher real demand (there must be a few savers who are still well behind on their retirement plans relative to 2007).
This does not require two authors … but there is a lot of tension between the optimism surrounding house prices and the reality of the bulk of domestic data. Pretty much everything else in the domestic data-set remains weak-to-flat (even the house building data).
The bottom line — the RBA seems a little further from a rate cut than i had imagined. Not because they don’t see the weakness i worry about — for they do — but because they have a little more hope than i do that the rate cuts they have delivered so far will boost demand via a wealth effect (one of the classic channels of monetary policy, and one that has been basically missing for the past 175bps).