I’ve had no problem forecasting rates throughout this year despite the consensus being strongly against me. But today, as I consider tomorrow’s call, I’m torn. Let’s start by taking a look at what the RBA said last about its settings:
The Minutes of the last meeting stated:
Members considered the significance of the inflation data that had become available over the past month. While revisions had altered the earlier quarterly profile somewhat, the latest data suggested that after a pick-up in underlying inflation in the first half of the year, there had been a moderation more recently, notwithstanding ongoing large increases in utilities charges. CPI inflation had remained above 3 per cent on a year-ended basis, but was expected to decline significantly over the next few quarters, as prices fell for some key food products that had been affected by adverse weather earlier in the year.
Information on economic activity suggested that the pace of growth in demand and output outside the resources and related sectors was a little lower than had been expected earlier in the year. The revised staff forecasts pointed to the likelihood of overall GDP growth being close to trend over the next one to two years, and inflation being consistent with the 2–3 per cent target.
Financial conditions had already been easing somewhat, with a range of lending rates edging down over the past couple of months. Nonetheless, with overall credit growth remaining low, financial conditions on balance appeared to remain somewhat tighter than normal.
Members discussed whether the improved picture for inflation meant that it was no longer necessary to maintain the slightly restrictive stance of monetary policy that had been in place over the past year. A case could be made for leaving rates unchanged on the basis that, unless the world economy turned down in a serious way, the expansionary effects of the high terms of trade and the associated investment build-up would, in time, assert themselves more fully, even though recent conditions had been softer than expected. In that event, policy settings on the tight side of normal would be appropriate over the medium term. In the meantime, the expectation that policy might be eased was itself being reflected in a reduced level of market interest rates.
The case for an easing in policy was that there had clearly been material changes to the recent course of, and outlook for, underlying inflation over recent months, while the downside risks for the global economy had increased. While the financial conditions that had been in place over the past year had helped contain inflation pressures in the economy, with the change in outlook that stance was no longer necessary. A more neutral setting would, on this view, be compatible with achieving sustainable growth and inflation consistent with the target over the period ahead.
On balance, members concluded that it was appropriate for there to be a modest easing in the stance of monetary policy.
I called this a “begrudging rate cut” a few weeks ago. There are three key ideas here. The first is that inflation is no longer a near term problem but it could still become so on the mining boom. The second is that demand in other parts of the economy is lower than expected. The third is that it is, therefore, no longer necessary to have a “somewhat tight” monetary policy and that a more “normal” or “neutral” setting was now appropriate.
There is nothing here about making interest rates expansionary. So, to divine the direction of tomorrow’s meeting we need to ask two questions. The first is hat is “neutral” or “normal”? I’ve done a few calculations and the average mortgage interest rate going back to 2005 is 7.54%. If you go back to 1995 it is, remarkably, still 7.54%. Completing our alignment of planets, today the average mortgage rate is 7.54%, after the November cut. So that tells us we are right on “normal” already. I’m happy as well to accept that as “neutral”. So, no obvious reason to cut again there. But it does beg our second question: has demand changed since the last meeting such that the RBA would want its policy to become expansionary?
As always in our schitzophrenic economy, the answer is yes and no. On the weakening side of the ledger we have the November NAB survey, which most importantly showed a weakening of its employment index, below zero for the second time in four months:
This was confirmed as well by the ANZ job ads, which fell again in November, the fourth consecutive month:
There are range other indicators too, that strongly suggest that unemployment is about to rise modestly, even if official job numbers are sticking to 5+% for now. The most important of these is the clear softening in wages growth apparent in the AWOTE and WCI (both wages indexes):
There’s plenty of other data showing weakness. I’m thinking especially of building approvals, house prices, credit and retail sales. But all of the data we’ve had for these since the November rate cut are for periods before November. Moreover, they’ve been weak all year and it hasn’t bothered the RBA boffins until the November cut when they determined neutral was the correct setting.
On the strengthening side of the ledger, we had a nice bounce in consumer confidence following the November meeting cut, jumping 6.3% back towards its long run average while the conditions index was up a more subdued 3.9% and the expectation index rose 8%. Consumer’s confidence in the economy was the major beneficiary of the RBA decision to cut rates with expectations over the next year up 18.8% while expectations over the next 5 years jumped 7.4%:
We also had all of the wild capex and construction numbers of the mining boom, best captured in this one ABS chart:
This alone will add some good impetus to Q2 GDP. And good news was not restricted to mining. Another dimension of the capex numbers was a hint of recovery for manufacturing investment and the November PMI, although still contracting, showed growth in export orders for the time in as long as anyone can remember, indicating that the weaker dollar, down some 12% or so from its highs, is already providing some stimulus to demand.
And finally, there’s AFG’s Friday mortgage numbers for November, which showed a disturbingly large bounce in activity amongst property investors, the bane of Australian economy. I’m not sure whether the RBA would watch this index but surely its industry liaison would pick up on the bounce. And this does highlight another consideration for the RBA, monetary policy lags.
Then there’s the international context, which includes further disintegration in the European and Chinese economies, a mini-cycle improvement in the US economy and a worsening global bank freeze, as well as the failure of covered bonds for Australian banks and mass central bank intervention from Beijing to Berlin. In general the bulk commodity prices have not deteriorated since the last meeting.
The final consideration is the Christmas break, which may force the RBA to think preemptively.
I note that there are no confident calls in the broader media about the meeting and economists are evenly split, even if interest rate markets are certain (which is clearly wrong even if it turns out to be right).
That’s a lot of cross currents to digest.
My base case remains that Europe will descend into a nasty recession in the first half of next year and that China will also grow more slowly than many expect at least until mid-year. I also expect the US mini-cycle to slowly succumb, so I certainly see rates falling through the first half next year. However, at this stage those are forecasts only and a decisive intervention by the ECB could mitigate that outlook. So, I wouldn’t be cutting rates on the international environment yet.
Regarding the banks, there has been no obvious jump in the use of the RBA’s “cash for coconuts” repo facility yet so the bank’s wholesale funding issues seems contained for now, so probably no reason to give them more spread yet either. On the local economy front, it’s swings and roundabouts with ongoing capex displacing more services activity but there already some green shoots from last month’s rate cut and the falling dollar.
And on the Christmas break, there is no reason why they can’t cut in an emergency meeting – even via phone hookup – if Europe does go pear-shaped.
I will, therefore, guess they they’ll stay on hold, but will freely admit that this one is a bit of a guess. My firmest recommendation is to sit this meeting out.
