What’s the State of the Economy?

The RBA made a subtle change to their concluding paragraph of their April post-meeting statement last week. Given that they had used the same words for the prior thirteen statements, and that the change occurred alongside downgrades to domestic and global growth, I thought the change material — but reasonable people can disagree, so the RBA needs to do some explaining.

It seems like Deputy Gov Debelle will be doing that explaining in his 10 April Speech, The State of the Economy.

So what is the state of the economy?

Growth is slowing, inflation is stuck ~1.75% (below the 2.5% target and outside their control range), house prices are falling, and the fiscal impulse from the federal budget is a little smaller than most hoped (though we may see more during the campaign). Most forecasters are still downgrading the global growth outlook, and the IMF seems sure to do so again when they publish the updated WEO on 10 April.

According to the AFR, the IMF are also going to downgrade their Australian assessment. The AFR story also notes that the property downturn has been larger and earlier than expected, and that the case for a rate cut is developing. Dr
Thomas Helbling, the IMF’s lead economist for Australia, noted the slowdown would reduce inflation pressures and make the case for a cut.

“maybe the inflation trajectory, the projection, shifts down a bit; labour market conditions are a bit weaker, and then by the very logic of the flexible inflation targeting regime, I would expect they would ease … If there are material changes to inflation trajectory and, or – and typically it will be both, there will be an ‘and’, to the employment picture, I think they will.”

When Deputy Gov Debelle speaks on Wednesday 10 April, I would expect to hear much the same. The local and global economy have both slowed. Inflation pressures have declined a little, and there’s scope to ease without upsetting their financial stability mandate. In any case, the labour market seems far from delivering the 3.5% wage growth that’s consistent with hitting their inflation mandate.

As a side note, last week’s Federal Budget (see the notes to table 1 on page 2-5) assumes spot for AUDUSD (~71c) and uses market pricing for rates — so in a sense, the Australian Government has already assumed (and spent) the rate cuts.

The forecasts for the domestic economy are based on several technical assumptions. The exchange rate is assumed to remain around its recent average level — a trade-weighted index of around 61 and a US$ exchange rate of around 71 US cents. Interest rates are assumed to move broadly in line with market expectations.

The growth (and wages) numbers in the budget look too high to me, so it seems unlikely that recently higher Iron Ore prices will fund further tax cuts.