Is Stevens 80% sure about August?

Following the Q2 CPI report, the market is pricing the August meeting at ~80%.

There are decent reasons for this: the unemployment rate continues to trend up, job ads continue to trend down, and the currency still hasn’t fully reflected the weakness in the terms of trade (a level ~85c would be more appropriate).

Still, with so much priced it’s going to be hard for Stevens to meet market expectations today. His most recent speechon economic conditions and prospects can hardly be called hawkish. The thrust of that speech was that the conditions for a pickup are in place, but that the confidence is lacking.

Turning to the current conjuncture, it can be observed, in conventional expenditure accounting terms, that some key areas are well placed to expand once they have the confidence to do so. Non-mining business investment, for example, as a share of GDP has been unusually weak – it is not much above its recession lows of the early 1990s. Many companies, rather than extending themselves, have been financially conservative over recent years and are sitting on very substantial sums of cash. It’s hard to believe that this configuration will not change at some point over the next few years.

Likewise, dwelling investment has been low for an unusually long period, with at least some households intent on reducing debt, thereby strengthening balance sheets. Households have accumulated a good deal of cash as well over recent years. Meanwhile, population growth is quite solid and it has been picking up a bit of late. If anything, we will need to build more dwellings than we have been over recent years. Meanwhile, interest rates are low, dwellings are more ‘affordable’, and finance approvals for housing purchases have risen by 16 per cent over the past year. So there are ‘fundamentals’ that favour a pick-up in these sectors.

Of course, we have to add two things. The first is that no-one can pretend to be able to fine tune this ‘handover’, to guarantee that the non-resources sectors strengthen, on cue, by just the right amount. We have, in fact, had a few handovers over the past five years – from private demand to public in 2009, then to mining investment subsequently. Now we are looking back to household dwelling spending, non-mining investment (and exports). Previous handovers have occurred, largely successfully. That doesn’t guarantee the next one will, though it does mean that we shouldn’t assume that it won’t occur.

The second thing to say is that much depends on ‘confidence’ – that intangible thing that is hard to measure and very hard to increase. We are talking here about confidence that the future will be characterised by growth, that there will be customers for products, that innovations are worth a try, and so on. That confidence seems pretty subdued right now.

So will we get more of the same today? Perhaps.

The risk seems to me to all be in the other direction. The data hasn’t been all that different to what the RBA expected. GDP looks like it’s on track to hit their forecast of ~2.5%y/y for the June quarter (which means that a sub-trend 0.5%q/q looks likely). Both headline and core CPI were closer to 2.5%y/y than the 2.25%y/y that they had forecast in the Q2 SOMP. The point of weakness is in non-farm GDP: where their forecast of 2.75%y/y looks too high by about 1/4 point.

Non-farm GDP is generally a better measure of what’s going on, and a 2.5%y/y result for the year to June seems more in keeping with the weakness in various labour market indicators and various business surveys.

It’s for the latter reasons that i think the RBA will cut their policy rate in August — it’s just that i have a hard time seeing Stevens be much more dovish than he was on 3 July. The RBA will probably cut in August, but i don’t think Gov Stevens will sound 80% sure about it at lunch-time today.