Access goes all in on rate rises

Boy, do we have a market in interest rates. From Bloomberg:

Australia’s central bank will increase interest rates three times in the coming year as a mining boom boosts wages and helps the economy recover from natural disasters, a Deloitte Access Economics report showed.

High resource prices and strong demand will boost Australian incomes and there won’t be enough workers to satisfy jobs growth, and that will push up wages, the Business Outlook report released in Canberra said.

“That boils down to a strong demand-weak supply scenario of the kind that makes central bankers sweat,” the research company said, forecasting “three official interest rate increases in the coming year — though none in the next little while.”

The interesting thing about this prediction is that Access in no way backs away from the weakness in the services economy. Rather, it expects it to worsen:

This industrial landscape – with its big winners and its many losers – is an almost guaranteed source of angst, and it looks set to dominate the outlook for several years.  Yet perspective is handy here:  even the sectors which look like ‘losers’ amid current conditions are also often indirect beneficiaries of the strength in national income that has been generated by Australia’s resources boom.

A number of insiders have told me the same thing. It’s kind of a Canberra orthodoxy that the RBA will ignore the two-speed economy. A sort of economist’s machismo. They may be right but as the Melbourne Institute argues, growth in the old economy is already struggling so much with rates at the current level that stagflation beckons. And that’s before any further external shock.

To my mind, the Access report has the scent of the ivory tower about it. I can countenance a scenario in which housing recovers somewhat and confidence stabilises leading to another rate rise to snuff it out but three would surely blow us all up.

Interesting that outside of Bloomberg, the MSM didn’t quote the three rises that I can find.

Below is an executive summary of the Access Business Outlook report and more below:

Business Outlook:  The ‘two speed’ screws are tightening

  • A Greek tragedy?  Forecasters are dialling down estimates for advanced economy growth in the wake of a surge in commodity prices and Japan’s awful earthquake.  Of the six largest rich economies, only the US and Germany are bigger today than three years ago, while government spending cuts and tax hikes are cutting a swathe through prospects for Europe’s drowning, slowing growth everywhere from the UK to Italy, Portugal and Greece.  That said, fears are overblown, and recovery is continuing.  China and India are starting to cool, but their slowdown – like the associated lift in their interest rates – is modest.  That not merely leaves their short term outlook excellent, it also means overheating risks remain.  With developed economies doing better than you think and emerging economies only throttling back a bit, the upshot is continued above trend global growth this year and next…
  • Yes, it is tough out there for many families and businesses.  Most of Australia’s growth engines are misfiring: (1) families are saving rather than spending; (2) stimulus has run its course; (3) housing construction – a pocket rocket in past recoveries – is limping into this one as interest rates drown out population pressures; while (4) our export gains in resource volumes are being mostly matched by lost sales to tourists, manufacturers and international students.  Add in the huge costs of floods and cyclones, and no wonder people are shaking their heads at hints that the Reserve Bank may raise rates further.  Yet flood and cyclone costs were a one-off, and production is already rebounding from those losses.  And one growth positive is enormous:  businesses (especially miners) want to spend a fortune on adding to their capacity, and that will power continuing recovery even if they only achieve a fraction of what they are aiming for.  So growth prospects are very narrowly based:  total capex (including the public sector and housing) will account for almost all Australia’s 2011-12 growth.  Business capex alone should account for almost two-thirds of growth.  That’s tough to do, but achievable…
  • The downswing in underlying inflation has been large, but it’s done its dash.  Poor productivity gains have left the cost of workers rising at the fastest rate for two decades, while growing demand will allow more businesses to pass on price rises.  Although that won’t be true in retail – where online alternatives are sharpening already fierce competitive pressures – the overall picture points to rising inflation, topped up by further gains in housing rents and electricity costs.
  • The slow sovereign defaults on Europe’s edge will further delay interest rate increases in rich nations, while rate hikes in emerging economies look more impressive than they really are (as they haven’t kept pace with inflation).
  • So the global monetary accelerator remains flat to the floor.  The Reserve Bank still expects to hike rates, though markets think ‘two speed’ pressures will keep them sidelined.  We agree rates will rise, but not for a little while. Higher rates will keep the $A well-supported.
  • Australia’s current account deficit is the smallest that we’ve seen for a while – and that is good news.  But great commodity prices mean businesses will build mines, ports, and railway lines, and these huge projects generate big import bills.  And resource booms boost family incomes as jobs grow and wages rise, while the high $A lifts the purchasing power of families.  That effect will also boost imports, suggesting the current account won’t stay small in the next few years.
  • Help wanted.  The world is desperate for Australia to grow faster, with the resources boom generating job opportunities in more sectors and States than you realise.  But though demand is there, supply isn’t:  migrant numbers are slumping, and the pace of retirement is rising.  So job gains are starting to slow, partly due to ‘two speed economy’ negatives, but now also due to a lack of workers as mismatches between job demand and worker supply become more evident.  That’s why you can now make more flipping burgers in Karratha than you can being a GP.
  • There will be yet another Tax Summit in a few months.  But it is a Spending Summit that Australia really needs – that’s where more bodies are buried these days.  The bad news is that neither the changes of government in Victoria and NSW nor the tough talk of the Feds has made much difference to public sector spending.  Although the need for cost control remains as urgent as ever, the nation’s politicians aren’t yet grasping the nettle with any enthusiasm.
  • On the sectoral front, the ‘two speed economy’ pressures on the industrial landscape are intensifying.  That has been partially masked by the striking impact of floods and cyclones, which hurt mining.  But the continuing stellar strength of the $A is combining with expectations of further interest rate increases ahead to mean the pips are squeaking across a range of sectors.
  • That is no surprise.  After all, value added per employee in mining is seven times the average, so the desire to see that sector contribute more to national income has set off a scramble that will boost construction before it can lift mining itself.  But both these two will struggle to grow as fast as they’d like as skill shortages will keep them on a short leash.  In turn, the pressure from high exchange and interest rates is making life extremely uncomfortable in much of manufacturing, as well as in tourism, parts of education, for retailers, and in farming.  Moreover, as the straitjacket on skilled workers is tightened over the next two years, many of the latter list of sectors will also find they face unwelcome wage pressure from mining and construction.
  • This industrial landscape – with its big winners and its many losers – is an almost guaranteed source of angst, and it looks set to dominate the outlook for several years.  Yet perspective is handy here:  even the sectors which look like ‘losers’ amid current conditions are also often indirect beneficiaries of the strength in national income that has been generated by Australia’s resources boom.

This is going to be fun.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the fouding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Comments

  1. Chris Richardson makes bold and provocative predictions that never turn out to be correct, but because he looks like Rudd without glasses and because he acts very confident, people listen to him.

    He will be wrong on this…but no one will care, as always

      • Because Assange is the biggest threat to the power establishment that has ever existed and because they control the media, Assange has been discredited and misrepresented.

        Richardson is the poster boy for Keynesian-pro Government types. There is nothing he cant fix with a graph and some analysis.

  2. If thats true we do get 3 rate rises.

    Thats the end of the property bubble in Australia.

    And who was it again – all those big hedge fund traders 18 months ago(with money behind them) saying that our bubble will burst with higher interest rates.

  3. 3 rate hikes!!
    You little ripper – 6% on my Super cash account means a max drawdown at sustainable levels for …
    I’m working on 20 yrs

    • Indeed Fred Dag. Even in regions that are on the wrong side of the two-speed economy, those people with low debt and substantial savings will be sitting pretty.

  4. Just a whiff of ivory tower?

    All of this points to a worsening of the two-speed economy, which will drive a deep wedge between the winners and losers in Quarry Australia. This has massive political and social implications which policymakers and the commentariat have hardly touched on.

    In such a scenario I believe wealth redistribution will become hugely important unless we want South East Australia turning into a ghetto. When the punters stop being distracted by the carbon tax and focus on the massive structural changes happening around them, all hell will break loose. Somehow I doubt policies that are strongly supportive of mining and oppose any kind of tax impost on mining companies will be popular in an economically-devastated South East.

    Perhaps this is an opportunity for MB to look five years into our future at the prospect of Australia as a welfare state supported by mining?

    • That’s if it happens, which seems very unlikely to me. The Melbourne Institute looks far ahead of Access on this. The economy is already stalling out at these rate levels. More hikes and the “adjustment” will become disorderly.

      • Yes, “disorderly adjustment” is one way of putting it.

        I hope sanity prevails as well, but if we see a strong inflation number this week, the bullhawks at the RBA will be pushing very hard for a hike.

    • Lorax

      A touch of hyperbowl there – South East Australia turning into a ghetto; economically devastated! I don’t think it’s going to be that bad. And the policymakers (not government) have commented on the transition several times.

      It was refreshing to see a more upbeat view of the China/India story and from where I am I would agree with H&H, a small dose of economist machismo, nonetheless nothing to suggest that it is not correct but probably overstates the positive. Do remember, although you decry ‘hope’ there a lot of China bears out there – and I do know your hope on that issue.

      For a good appraisal of things as they are:

      http://macrobusiness.com.au/2011/07/australian-stagflation/#comment-53149

      • Fanboy, I have seen very little if anything on the political and social implications of a deepening (and prolonged) divide between the winners and losers in the two-speed economy. Perhaps you could point me at something?

        As H&H says above, if we see three more rate hikes, the adjustment will become “disorderly”. If the adjustment is prolonged, and the RBA ignores the pain in the slow-lane of the economy, I believe the independence of the RBA will be called into question.

        At the risk of repeating myself, my hope for China is that they rebalance their economy away from investment and towards consumption. Less money for SOEs and party officials, more money for the average Chinese citizens.

        I have already read and replied to david’s comment.

        • I don’t think there will be deep social and political divisions between winners and losers, just a begruntled acceptance of change in the economic cycle – of which Treasury and RBA have advised will occur.

          Three more rate hikes – only likely given no global calamity – so hikes (not that 25bps is what I would call a hike – 75bps in total??s, rates are not especially high after all). It seems that global markets largely determine the AUD and as several commentators have remarked on recently, if Australia continues to ride the China growth wagon it will continue to attract attention, the dollar will remain high – you can bet the RBA will not run some sort of ZIRP. RBA has not raised rates in months, currently economy is stalling/adjusting, personally can see no reason to lower rates – housing has not collapsed and spending whilst restrained in some households is simply temporarily withheld in others, awaiting some certainty.

          We are not Ireland.

          • Quickly, another point on rates – housing is down, not out. RBA wants it to stay that way for some time longer – down, not out. Reduction in rates may provide just the breath of stimulus needed to revive housing – hence at this point, no reduction (mindful of the usual exclusions).

          • I don’t think there will be deep social and political divisions between winners and losers

            Mate, when one section of society gets fabulously wealthy while most others struggle, there are always deep social and political divisions. That’s how communism got started.

            You really are being incredibly naive if you think this won’t result in social problems. Perhaps you can’t see it because you are rolling in cash ATM? Maybe you need to visit an east coast tourist town?

            BTW, rates are not high by historical standards, but personal debt is at much higher levels, so debt servicing costs are much higher. 5% today probably equates to 10% during the late 80s.

          • One section of society is not going to get fabulously wealthy – I may be satisfactorily recompensed, I’m not fabulously wealthy. This is likely true for the majority in this sector.

            I’ve been in resources for a years and trust me, it’s swings and roundabouts. That’s why I reckon, in general, resources people know how to go with the flow – when it’s good, terrific and when it’s not – oh well, there’s always overseas. Fluid and adaptive.

            As other sectors may have to learn to be.

            As a nation we’ve maxed out the debt on housing speculation and now need to deleverage and adjusting to that is going to the major problem facing the Australian economy. The RBA has declined to raise rates for months and at present does not look about to (although Stevens would, happily).

            We are not about to see the rise of new communism, though we may see many call into question the whole Chicago school paradigm. But we are a part of it, have benefited from it and are now feeling the sting in the tail. Interesting times.