Up, down and sideways

 

Here are four bank takes on today’s rate decision, the pick being the first, from Brian Redican at Macquarie Securities.

Macquarie

The RBA Board’s decision not to raise rates at its August policy meeting will obviously be welcomed by those firms struggling with weak consumer demand, as well as some mortgage holders with stretched balance sheets.  But the important question is whether this is simply delaying the inevitable, or whether it represents a more permanent stay of execution.  

We suspect that many analysts will argue that the current uncertainty in global financial markets was the main reason the RBA didn’t tighten policy in August.  And as that uncertainty recedes, the RBA will simply increase the cash rate in late 2011 or early 2012.  Of course, this view hinges critically on the RBA’s outlook for the economy remaining essentially unchanged from earlier this year.  

The statement released after the August Board meeting does make some concessions to recent softer data — mainly around the international outlook — but continues to suggest that medium-term Australian growth will be at trend or higher.  It noted that the Board explicitly considered whether a rate hike was warranted and cited “uncertainty in global markets” as the main reason to refrain this month.  But the Board remains concerned about the inflation outlook.  As such, this is hardly an admission that the RBA has changed its medium-term view.  The RBA will release updated growth and inflation forecasts in its quarterly Statement on Monetary Policy on Friday 5 August.  In our view, the RBA will trim its short-term growth forecasts, but is likely to retain its optimistic growth forecast for 2012.  For that reason, it seems likely that most analysts will continue to speculate on when the RBA will next hike rates. 

In contrast to the “consensus view”, we think the window for a rate hike may well have closed.  While many analyst are comparing the Australian economy today to that existing in 2007, we think there are more differences than similarities.  For example, in 2011 compared with the end of 2007:

  • Retail sales are now weaker (8% vs 3%)
  • House prices are now weaker (14%YoY vs -2½%)
  • Residential building approvals are now weaker (14%YoY vs -15%)
  • Motor vehicle sales are weaker (~90K per month vs ~85K per month (or 75K per month with temporary Japanese impact)
  • Non-residential building approvals are now weaker (~$2½ billion per month vs ~$1½ billion per month)
  • Credit growth is now weaker (15%YoY vs 3%)
  • Equity markets are lower (Australian index was 6,700 vs 4,440)
  • The A$ is much higher (~US$0.93 vs US$ 1.10)
  • Fiscal policy is now highly contractionary

In contrast, the similarities of the economy with 2007 are:

  • Commodity prices are extremely high (even higher today than 2007)
  • Mining investment outlook is incredibly strong
  • While the unemployment rate is 1% higher than it was in 2007, the labour market is still tight
  • While wages growth is less than in 2007, it is still strong

It seems clear to us that the RBA has been struggling to prosecute its argument for tighter policy against these gathering headwinds, but the release of the Q2 CPI data did provide a possible excuse to push rates higher. By not seizing that opportunity, we think it will be more difficult for the RBA to justify tighter policy in future.  This is because inflationary pressures are likely to recede as fresh food prices return to more normal levels and petrol prices stabilise in 2011H2.  And, without interest rate cuts (or a sharp exchange rate fall) there is no reason to expect spending to reaccelerate.  As such, we think that interest rates have now peaked.  

That said, the RBA is clearly not in any mood to countenance cutting rates any time soon.  In the short term, only another financial crisis or collapse in commodity prices would precipitate such a move, and neither development is in our central scenario.  For that reason, we think that rising unemployment will be the key factor to watch.  Despite sluggish growth, the unemployment rate is unlikely to surge higher in the next few months, but it is likely to become a growing issue in 2012.  And if the unemployment rate pushes back through 6%, then the discussion of a rate cut would swing from a question of “could the RBA cut rates?” to “when will the RBA cut rates?”  But that is probably an issue for the second half of 2012.

The next few months

The economy will clearly be healthier in the next few months without a rate hike, than if the RBA did tighten policy again.  But this is not to say that the economy will be strong outside of the mining sector.  The recent weakness that we have seen in retail spending and housing has occurred with the current level of interest rates, and so we think that investors can pretty much expect more of the same over the remainder of the year.  

Amongst the plethora of indicators to monitor, we think a key development to watch will be auction clearance rates, as a useful high-frequency indicator of household behaviour.  A stabilisation of auction clearance rates at current levels would provide some grounds for hope that growth won’t get any weaker.  But a further step down in clearance rates (and less turnover) in the crucial spring selling season, would suggest that house prices will be under further downward pressure.  This — in combination with ongoing speculation of rate hikes — would further undermine consumer confidence and ensure that spending in the lead-up to Christmas remained weak.  The concern then would be whether some of the smaller retailers could survive another poor year, with the risk of a further rise in insolvencies and increasing redundancies.  

So far, the RBA has demonstrated remarkable unconcern about the plight of retail spending.  However, we think that nonchalance would quickly change if retail employment started to reflect the weakness in spending.  This would particularly be the case if it coincided with job-shedding in the housing sector due to weaker activity there.  

The other area to watch in the next few months will be the A$.  This is another one of those times where a perfect storm could be brewing for the A$.  In an environment where US policymakers are doing all they can (deliberately or not) to push down the US$,  Japanese policymakers are threatening to intervene to stem any rise in their currency, and even the Swiss authorities are uncomfortable with the franc being considered the new safe haven, Australia’s high interest rate settings stand out like a beacon.  To be sure, if the RBA had tightened policy further it would have likely made things even worse.  But even the current level of interest rates may well prove to be an irresistible lure to foreign investors (including official investors) and push the A$ to new highs.  And that would further aggravate the pain for the manufacturing sector – still a large employer — and the tourism sector.  

Of course, we could be wrong.  The benefits of the mining boom may well be about to surge through the economy in which case the RBA’s decision not hike rates in August was simply a temporary reprieve for mortgage holders. But either way, the next 6 months are likely to be critical in determining which view is more accurate.   And with such disparate scenarios being discussed, it will clearly be a very challenging environment for investors.

NAB

As we and most economists predicted (20/24 of economists in last week’s Bloomberg survey predicted steady rates) and as formal market pricing had suggested, the RBA left the cash rate unchanged at 4.75%

Even so, it’s clear from the final paragraph of the Statement from the Governor that they want monetary policy to continue to exert a restraining influence over the economy; they’ll be hoping that line gets a lot of coverage in the press over the next few days talking of rate rise risks

Today’s meeting was not a totally straightforward affair.  The RBA Board considered whether “recent information” (for this read CPI) meant they should have hiked again, but they judged it prudent to maintain the current setting, especially given the international market uncertainty

Their review of the international economy has shifted more to note some downside risks.  They say that it’s not clear how persistent the recent global slowdown will be and they say in connection with China – Australia’s most important trading partner and growth driver now – that “most indications suggest only a mild slowdown so far”.  There are hints they might be worried about the risks of a sharper slowing in Chinese growth? There’s some change in language/ risk there

On the domestic economy, they continue to observe the disjointed performance across sectors.  While they’ve seen resource investment accelerate, they have given prominence in this statement to “precautionary behaviour by households” as holding back growth and together with a slower coal recovery they’ve downgraded their 4¼% GDP growth through 2011 published in May to “about trend”.  That’s a downgrade of about 3¼-3½%, a downgrade of around 1%.  That’s material

The Q2 CPI was definitely a worry for the RBA.  The statement points to the rising trend in inflation over the past six months and they say that these measures (eg RBA underlying inflation) remain consistent with the 2-3% target on a year ended basis; so they took no comfort from the two 0.9 s underlying inflation prints seen in Q1 and Q2.  There is also the policy sting in the tail that the “Board remains concerned about the medium term outlook for inflation”; no easing message there

So there we have it with rates on hold again.  A tightening policy bias is retained and given they considered the case for a hike at today’s meeting, that’s where they want the bias of policy to remain with restrictive monetary policy, a high AUD and softer asset prices all working to restrain inflation

NAB’s economic forecasts of some stabilisation and then pick-up in domestic demand through this half continue to call for a hike in the cash rate by year end (our forecast is December) and a final cyclical tightening in Q2 of 2012.

Deutsche

RBA leaves the cash rate at 4.75%, an “acute sense of uncertainty in global financial markets” outweighing the Q2 CPI, is our one line assessment.

The second last sentence of the statement sums the decision up in our view: “At today’s meeting, the Board considered whether the recent information warranted further policy tightening. On balance, the Board judged that it was prudent to maintain the current setting of monetary policy, particularly in view of the acute sense of uncertainty in global financial markets over recent weeks.”

That is, the uncertain global environment has – for now – outweighed the uncomfortable domestic inflation backdrop. This global uncertainty is also reflected early on in the statement, where the Bank notes (unchanged from July) that the pace of growth in the global economy slowed in the June quarter. Further on in the discussion on the global economy the Bank observes that “downside risks have increased” with concerns having grown “over the outlook for the public finances of both Europe and the United States”.

On the domestic economy the statement is little changed as far as the description of the economy is concerned. That said, the consumer sector appears to have been weaker than the Bank was anticipating some months back, with the statement noting that “precautionary behaviour by households also looks likely to keep some areas of demand weaker in the near term than earlier expected”. This comment may also reflect the sharp drop in consumer confidence in July (note that our own analysis suggests a decline in support for the Government may have been behind much of that circa 8% slump in the Westpac Melbourne Institute consumer sentiment survey last month – see Recent Influences on Consumer Sentiment published on 28 July 2011.)

On inflation the Bank says that: “measures that give a better indication of the trend in inflation have begun to rise over the past six months, after declining for the previous two years. While they have, to date, remained consistent with the 2–3 per cent target on a year-ended basis, the Board remains concerned about the medium-term outlook for inflation.”

As far as the actual decision is concerned the statement notes that “It is appropriate under such circumstances for monetary policy to exert a degree of restraint”. After considering credit growth, trends in asset prices and also the exchange rate, financial conditions are judged be to “tighter than normal”. Reflecting the likely closeness of the decision the statement notes that the ‘Board considered … policy tightening’ (see the start of this note for the full quote).

Looking forward, the key swing variable appears to be the global environment. In that regard we doubt whether the coming month will provide sufficient comfort to enable the Bank to tighten if they couldn’t get across the line today. Hence any monetary tightening in Australia is likely to come later in the year and require greater certainty on the global outlook.

Our ‘call’ on the RBA is unchanged on the back of this statement. We continue to look for a rate hike later this year (most likely in November), with the risk on that view being that any move is pushed into 2012. Absent a global ‘meltdown’ we think rate cuts are unlikely. For reference the full text of today’s statement as well as the 5 July statement are reproduced over.

CBA

Views on the direction of interest rates have shifted back and forth in the past few months. In the end the RBA has decided to maintain the “prudent” approach it identified at the July meeting and left the cash rate unchanged in August.

The bald facts of the “no-change” decision probably conceal the intensity of the debate. The range of QII price outcomes indicated that the inflation trajectory has turned up. And that the top end of the RBA’s target range is under threat. The underlying CPI, for example, was running at an annualised pace of 3.5% in HI 2011. This set of outcomes would have had a rate rise on the table for discussion. And in normal times would probably have seen a rate rise delivered.

Some of the flavour of that debate is evident in today’s Statement. The RBA notes explicitly that “the Board remains concerned about the medium-term outlook for inflation” and the Board “considered whether the recent information warranted further policy tightening”. But it is also clear that the difficulties in getting a clear read on the economy make it prudent to wait. Each medium-term growth positive, for example, comes with a qualifier:

•global expansion continues but growth slowed in QII;

•the central scenario has global growth running above trend but downside risks have increased; and

•in the domestic economy resource related areas are strong but other areas are suffering from the high Aussie dollar and cautious consumers.

Conversely, qualifiers around the inflation outlook emphasise the upside risks:

•CPI inflation should decline but trend inflation has turned up; and

•the labour market / wages story looks to be in balance but productivity growth is weak.

Attention will now turn to the quarterly Statement on Monetary Policy (SMP) due on Friday. This Statement will allow policy makers to flesh out the thinking behind today’s decision and will also provide updated forecasts for growth and inflation.

The RBA has already indicated that it will revise down economic growth projections for the current year. But the inflation story is less clear cut. Forecasts in the May SMP suggest the RBA was expecting an underlying CPI increase of 0.7% in QII and a headline rise of 0.8%. Both were short of the mark. The RBA GDP forecasts may well be revised down but the risks lie with upward revisions to the near-term inflation projections.

Relative to the May forecasts, the currency is a little higher than assumed and oil prices are about the same. The main difference is the underlying rates profile which the RBA typically proxies on market pricing. Back in May the market had 2x25bpt rate rises priced in by mid 2013. Current pricing has some chance of a rate cut  over that period. This shift in working assumptions also favours the chances of upward revisions to CPI projections.

The likely downward revisions to the growth profile for 2011 reflect the much weaker than expected QI GDP outcome and an assumption that the post-flood recovery in coal exports will take longer. The base effect of QI weakness is locked in.

But there are some tentative indications that the rate of recovery in the coal sector is now accelerating. So the downside to revisions may be limited.

The RBA’s medium-term projections should still involve above-trend growth and the inflation testing the upper end of the 2-3% target. Both outcomes underlie the tightening policy bias. We have a rate rise pencilled in for November. Given today’s Statement, the triggers for a move revolve around an easing in financial market nerves and some signs in the domestic data that the positive medium-term fundamentals are seeping through. The labour market is the key variable to watch.

 

Comments

  1. From Macquarie Securities:

    Comparing 2011 to 2007…

    “Fiscal policy is now highly contractionary”

    Ahem. No. Simply wrong. Running large deficits now (headed towards rough balance) compared with the very large surpluses of 2007 in no way could be argued as indicating ‘highly contractionary’ fiscal policy now compared to then.

    • But the direction of fiscal policy is contractionary, as they have vowed to get back into surplus…so the spending has been DONE, and its Government austerity time…

      In 2007, Rudd had a warchest of over 20 bill (gifted to him) to spend on idiotic stimuous schemes.

      • Sandgroper Sceptic

        Given the record of Labour since 2007 you have to question if they will ever achieve surplus. They seem to keep coming up with “savings” that are actually new or higher taxes. I think budgetary expenses are forecast to grow by 2% real which is pathetic fiscal management. How about actually cutting the size of government?

  2. +1 Increased taxes described as ‘savings’ and the media are now so trained they don’t even mention it. It’s a dangerous situation.I’m damned sick of Government spin and BS. Labor govts seem to specialise in it but I’m sure they are not alone in that.
    Sorry i know I’m off the point…just a rant!