I really quite enjoyed this morning’s speech from Glenn Stevens. It was lively and candid and offered a couple of points worth noting for monetary policy debates.
The first point I want to make is that Stevens has rather subtly ridden to the defense of the RBA board:
By the time of the May Board meeting, there was evidence that the pace of underlying inflation had started to pick up. I myself felt that the Board was still well placed to sit still at that time. We had already put in place a response in advance of the expected pick-up in inflation and it is not necessarily always wise to respond to one high (or low) figure. Nonetheless, the updated forecasts carried a fairly clear message: policy would probably need to be tightened further, at some point, if things continued to evolve as expected. The Bank said that – indeed there was no other credible thing we could have said.
In the ensuing months, little has changed about the outlook for resources sector investment. More large projects have been approved and the pipeline of future investment looks very large. On all the available information, resources sector investment will probably rise by another 2 percentage points or more of annual GDP over the next couple of years. Prices for important commodities remain high and the nation’s terms of trade are at an all-time high in the current quarter.
At the same time, it has become clearer that precautionary behaviour by households and some firms is exerting restraint on the pace of growth in demand, and that the higher exchange rate is diverting more demand abroad. This is putting pressure on trade-exposed sectors. Moreover, the sense that a higher exchange rate might not just be a temporary phenomenon may be leading to a pick-up in the pace of structural change in the economy.
Note that, contrary to some of the more inflammatory drivel drivel written about the RBA Board, Stevens has confessed that he was on the side of the Board in choosing not to raise rates in May. Moreover, his description of the subsequent months suggests he was of the same mind ever since:
In the ensuing months, little has changed about the outlook for resources sector investment. More large projects have been approved and the pipeline of future investment looks very large. On all the available information, resources sector investment will probably rise by another 2 percentage points or more of annual GDP over the next couple of years. Prices for important commodities remain high and the nation’s terms of trade are at an all-time high in the current quarter.
At the same time, it has become clearer that precautionary behaviour by households and some firms is exerting restraint on the pace of growth in demand, and that the higher exchange rate is diverting more demand abroad. This is putting pressure on trade-exposed sectors. Moreover, the sense that a higher exchange rate might not just be a temporary phenomenon may be leading to a pick-up in the pace of structural change in the economy.
So, either Stevens is rewriting his own history now that growth and inflation are easing, or those self-serving commentators that alleged a Board putsch at the RBA to bail out their own failed forecasts should publicly apologise. Obviously, I prefer the latter.
The second point of interest is that the Guv did offer some further guidance on what circumstances will enable rate cuts. Stevens perused international dislocations then:
Turning back to the implications for Australia, periods of sudden increases in anxiety within international financial markets are moments when, if at all possible, it is good to be in a position to be able to maintain steady settings. In the recent few meetings, the Board has judged it prudent to sit still, even though we saw data on prices that were, on their face, concerning. To be in that position of course requires timely decisions to have been made in earlier periods.
Looking ahead, the task for the Board is to assess what bearing recent information, and recent international and local events, will have on the medium-term outlook for demand and inflation. They probably won’t have much effect on the large-scale investment plans in the resources sector, but households and firms watching what is happening may continue their precautionary behaviour for longer than otherwise. This would presumably dampen demand somewhat compared with the outlook set out in the Statement on Monetary Policy published in early August; it may also condition wage bargaining and price setting. If so, that may act to curtail the upward trend in inflationary pressures that has, up to this point, appeared to be in prospect.
So, rate cuts will come in the event that subdued demand diminishes inflation. Let’s not forget that the speech began with, and was framed in, a discussion of inflation targeting. No decline in inflation then no rate cuts.
Mining wouldn’t be popular in that event but I think it unlikely to eventuate. My base case remains recession for the big Western economies. Decoupling is a myth. Inflation should fall.
