RBA Statement dissected

The Statement accompanying the announcement of the RBA’s decision not to move rates this month has just been released and from our point of view it is a very dovish insofar as the RBA spends most of its time talking about downside issues with only inflation as a risk to higher rates.

I still think they are struggling with the difficulty of understanding how their view of the domestic economy and global economy is going awry but they are least granting themselves their usual intellectual alacrity to watch as things evolve but there is a clear softening in rhetoric over the past couple of months.

 Lets walk through the statement and then give a conclusion.

 Global economy

 The global economy is continuing its expansion, but the pace of growth slowed in the June quarter. The supply-chain disruptions from the Japanese earthquake and the dampening effects of high commodity prices on income and spending in major countries have both contributed to the slowing. The banking and sovereign debt problems in Europe have also added to uncertainty and volatility in financial markets over recent months…A key question is whether this more moderate pace of growth will continue.

Interpretation: not really much required there, they see the slower economy as a risk and indeed the way they argue that things are probably still ok is one of the most interesting parts of the statement.

Despite the challenging international environment, the central scenario for the world economy envisaged by most forecasters remains one of growth at, or above, average over the next couple of years. A number of countries have tightened monetary policy but, overall, global financial conditions remain accommodative and underlying rates of inflation have tended to move higher.

Interpretation: “envisaged by most forecasters” the behaviouralist in me says they are wrapping themselves in a blanket of “it’s not just us getting it wrong” and that tells me they are struggling at the moment to get their arms around the dynamics and the quick change in their outlook.

Domestically

 They are still trying to be upbeat and signalling that they retain their central tendency when they say,

Australia’s terms of trade are now at very high levels and national income has been growing strongly…Investment in the resources sector is picking up strongly in response to high levels of commodity prices and the outlook remains very positive.  A number of service sectors are also expanding at a solid pace.

 But its not all rosy,

 …conditions vary significantly across industries…cautious behaviour by households and the high level of the exchange rate are having a noticeable dampening effect. The impetus from earlier Australian Government spending programs is now also abating, as had been intended.

Interpretation: We still have a barbell economy and we still have our central tendency so we still think we’ll tighten eventually.

Their growth outlook is interesting because they cite the recovery from the floods and cyclones but ad, very importantly I would say,

growth through 2011 is now unlikely to be as strong as earlier forecast. Over the medium term, overall growth is still likely to be at trend or higher, if the world economy grows as expected.

Interpretation: Those highlighted words are added to the sentence this month! Thus, We are faced with weaker growth and it is crucially now more dependant than ever on what happens off shore. I think that is a nod to a risk of a Chinese mis-step. Perhaps I’m over reading it but i think it is a really interesting sentence.

Once again they are highlighting that the employment market is softening with leading indicators pointing to more softness and the corollary of this has to be more concerns at a household level about what is going on in the economy so more domestic household cautiousness seems a distinct probability. Crucially they highlight again that skills shortages are only in mining and related sectors. So we shouldn’t see a wages breakout.

Demand for credit remains weak for households. 

Credit growth remains modest. Signs have continued to emerge of some greater willingness to lend and business credit has expanded this year after a period of contraction. Growth in credit to households, on the other hand, has slowed. Most asset prices, including housing prices, have also softened over recent months.

Interpretation: In an economy where credit drives everything don’t expect too much good news here. Consumer cautiousness will remain and thus the retail sector will be subdued even if business credit is holding up for the moment.

Inflation

Don’t worry,

Year-ended CPI inflation is likely to remain elevated in the near term due to the extreme weather events earlier in the year. However, as the temporary price shocks dissipate, CPI inflation is expected to be close to target over the next 12 months. In underlying terms, inflation has been in the bottom half of the target range, though a gradual increase is expected over time.

Interpretation: Don’t worry about inflation. Core might rise but we know that.

So all in all they left rates on hold. No surprise there but I truly think this is a further iteration of the softening of their very aggressive stance from back at the May SoMP. Heaven Knows what drove their aggression back then but the reasons for the U-Turn are obvious. Uncertainty has grown in the Australian and International economies.

Rates are on hold for a while.

The implications for asset prices are obvious from the underlying themes in this statement should they hold for an extended period as we believe they will. Remember though we are faced with benign growth not recession so this is a good thing and a great time for households to rebuild balance sheets.

House prices will continue to pull back from lack of credit demand and a lack of upgrader demand while this cohort focusses on paying down debt.

Equities are faced with the earning potential of a slow growth global and domestic economy so stock picking is a must rather than just an index play. There will still be very worthwhile investments out there –  just need to find them.

The ASX200 is off a few points from 2.29pm before the statement and it is true that global atmospherics are probably more important than what the RBA said but there is likely to be ongoing adjustments to those companies faced with this slower growth climate and impact. Banks for example from the lower demand for credit.

Short term interest rates are on hold for a while with the market expecting no rate hikes for more than 12 months and starting to think about rate cuts. Probably too soon at present but in this environment Australian ADI Term Deposits have to be offering the best risk adjusted return on the planet at the moment.

Longer Term Rates are a little lower and can probably fall a little further in time. We may see rates close to where they were the last week in the Greece induced panic again.

The AUD/USD is holding in pretty well and a benign global growth environment doesn’t hurt too much. A reappraisal of Australia’s growth prospects will take some support away from it and this might kick it back toward the bottom of the recent range but a substantial fall should not arise from this statement or the outlook it suggests.

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This blog is for information only and does not constitute advice. Neither Greg McKenna, Lighthouse Securities nor MacroBusiness has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

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Comments

  1. 100% agree on the dovish interpretation.
    I got as far as “A key question is whether this more moderate pace of growth will continue” and thought Wow! The simple fact that they are asking the question, and not just continuing with with the usual gung-ho rhetoric, just about knocked my socks off.

    • Yes Avid I agree, however we need to wait for the next statement to really get an idea of the logic.

      My questions really revolve around this statement.

      “Credit growth remains modest. Signs have continued to emerge of some greater willingness to lend and business credit has expanded this year after a period of contraction. Growth in credit to households, on the other hand, has slowed. Most asset prices, including housing prices, have also softened over recent months.”

      Is this a surprise to them? They set the price of credit, they know how indebted households are and they know that housing is a credit driven market so as the price of credit rises the rate of issuance falls and therefore so do prices.

      Surely this cannot be a surprise to them! Yet I am reminded that Guy Debelle was able to perform this disconnect in logic in his latest speech.

      http://macrobusiness.com.au/2011/06/guy-debelle-on-banking/

      If the rest of the RBA also shares his position on this, then maybe I need to re-assess my opinion of their ability to steer the economy towards investment without screwing it up.

      • I think the message is that household propensity to save has changed.

        Well, at least they have noticed. When you think about it, in an uncertain world saving makes a lot of sense, especially when the interest on savings has improved (and it has), and the returns from borrowing (yields on housing) are falling (which they are).

        It does make you wonder about the theory that expected future inflation determines current propensity to save or consume. As I recollect, that theory says if households expect future prices to rise, they will increase current spending, adding to current demand, running down inventories and bringing forward the acceleration of prices. Anchoring inflationary expectations has therefore been a principal goal of monetary policy since at least the 1970’s.

        Maybe this theory only holds good when households are confident about their future incomes, and that the converse theory now applies: when households are anxious about their future economic circumstances, they will increase their savings even if they expect prices to rise.

        This is a cycle of gloom. It says “Deny yourself any pleasure today, because things will be even worse tomorrow…….”

        I’m starting to think Adam Carr is a wide-eyed optimist.

        • >This is a cycle of gloom. It says “Deny yourself any pleasure today, because things will be even worse tomorrow…….”

          Yes, and as we know that is the beginning of debt deflation. We aren’t quite their yet as credit growth is still positive, but if the trend continues the RBA is going to have to drop rates to try an kick start lending again.

        • And consumers are wary: credit conscious, stagnant property values, increasing utility charges, higher petrol costs (lucky to have strong dollar), carbon tax confusion, poor governance and RBA constant threat of rate rises. Oh, and the gloomy global outlook. Doom at every turn.

          I think it was the time for action. Time for someone to take control. But again, we’ve missed the boat. So this gloomy atmosphere will continue indefinitely – yet we have record ToT, near full employment, lowish interest rates and a healthy resources sector. What more do we want? What we need is direction and a Government capable of delivering it. We’ll be waiting a while then, wallowing in gloom – when we should be satisfied and thankful we have pulled through so well in comparison to other economies.

          We are a country that has done fairly well in a range of activities – something we should promote and have fair justification feeling OK about. Instead, we are behaving like spoiled kids and are declining into a nation of whingers.

          • >I think it was the time for action. Time for someone to take control. But again, we’ve missed the boat.

            Well 3d1k that depends on whether you think something is already happenning.

            You are correct about the gloom, but that is because people are finally being forced to stop using credit because the IRs are being set at a level to stall their credit growth. That is what all of the whinging is about.

            This is obviously an intentional setting, the question for me is whether the RBA/government understands how to manage the fallout, and continue to steer an economy in transition without it all collapsing around us.

          • Charles Ponzi

            Gloom and doom at every turn except for the great news that house prices are falling. No whinging here.

  2. The key variables all point to at-best muted expansion. The labour market, underlying inflation, credit creation, fiscal settings and so on are all consistent with a low-growth path.

    So it is very apt of the RBA to point out that “a key question is whether this more moderate pace of growth will continue.”

    This the issue that is puzzling equity markets, governments, bankers, households and businesses alike all around the world. Will growth momentum revive? Can the global economy absorb any new shocks? Will the 2011 deceleration prove to be temporary or will it presage renewed contraction?

    At a more strategic level, this invites us to consider whether we are masters of our destiny or not? Can policy determine outcomes when there are powerful extraneous legacy factors impinging on current economic behaviour?

    These things are arguable, but at the least, policy makers have to try not to make things worse for households, businesses and governments than might otherwise turn out to be the case.

    In this context, the main point has to be that the world economy needs a long expansion if the harm endured in the crisis of 2008-9 is going to heal. Even if the growth rates are slow, growth is vastly better than contraction and it is wise not to take risks with the economy.

    Perhaps in boardroom of the RBA this means that if it ain’t broke, don’t try to fix it.

    • “Perhaps in boardroom of the RBA this means that if it ain’t broke, don’t try to fix it.”

      Nail. On. The. Head.

  3. “Heaven Knows what drove their aggression back then.”
    .
    Maybe Glenny and co wanted to excite the bullhawks a lil bit – el Joye and Mad Adam in particular. And boy, did they swallow the bait – hook, line and sinker.
    .
    It also had the (desired?) impact of driving fear into the heart of any prospective mega mortgage mug whose world view does not strech beyond what is written in the MSM.

  4. It’s staggering these guys are mind numbingly pre-progammed to not make one single logical connection what-so-ever between a credit driven asset price and quantity of debt issuance.

    We’re at the mercy of the dumbest smart guys in Australia.

    A $4.15 trillion asset

  5. RBA quote:

    “growth through 2011 is now unlikely to be as strong as earlier forecast. Over the medium term, overall growth is still likely to be at trend or higher, if the world economy grows as expected.”

    My fix:

    “growth through 2011 is now unlikely to be as strong as earlier forecast. Over the medium term, overall growth is still likely to be at trend or higher, if the world economy grows as expected, AND growth in Australian private credit continues pretty much as it has the last 10 years”

    There we go, Glenn: fixed! 😉