There is little doubt the that the RBA should and will leave the cash rate unchanged today. Global manufacturing is enjoying its seasonal post-Christmas upswing and the iron ore price is flying. Markets agree, pricing only one cut in the next twelve months:
Probably around September:
In short, credit markets are pricing a soft landing for Australia later this year when the economy launches over the mining investment cliff. That is the point at which the fantastic run of mining investment growth goes into reverse.
But it’s a big drop.
The most important news in the new year has been very under-played in the press and national discussion. It was last week’s decision by Shell to shelve the Arrow and Browse LNG projects, canning some $65 billion in investment, ensuring that the other side of the mining investment peak will be steep. The following chart from CBA is illustrative:
The blue mountain is now operative. Roughly speaking that’s about 1% in GDP retrenching every year to 2017. This is the vital point. It is not not growing, the end of the boom detracts from growth. So we’ve got to find 2% of GDP elsewhere just to make up the gap to current growth levels of 2.5%.
The broader economic cycle may be of some help. The global economy will have a better year than than last. Perhaps a half a percent improvement to 3% growth or so. But despite the equity market froth, the globe is not (in my view) entering some new virtuous cycle of private sector growth. Every year since the GFC, the global economy has shown the same underlying pattern at this time of year. It bounces into a year-end Christmas cycle as retail gets a boost and manufacturers enjoy an inventory draw-down. Then, as the year settles into its rhythm around March and new normal savings patterns reassert themselves, manufacturing finds itself well-stocked and production starts to slide. The greatest likelihood is that US, European and Chinese growth will ease into the second half, with commodity prices following suit.
The pattern is obvious in the JP Morgan global PMI and I see no reason to think that this year will be different:
These various factors are why the RBA boffins were out last week protesting against surplus politics (and Warwick McKibbin rejoins them today). They can see Australia’s investment cliff coming and would rather the hole be filled with something more useful than speculative household debt. They have only one lever to pull but do not want to pull it. Sadly for the RBA, the great likelihood is that surplus politics will persist into the election and perhaps intensify afterwards.
The statements last week on surplus politics was a new direction for the central bank. They violated its communications protocols and were a direct intervention in fiscal policy, undermining the bank’s political independence. They were nonetheless right, to some extent in content but absolutely so in spirit. Our two political parties have locked themselves into a kindergarten conflict of policy immaturity even as the greatest economic challenge since the GFC slouches towards Australia. The RBA is the only grown-up left on the block and it must lead on macro discussion and policy.
Thus, although rates will and should hold today, the RBA should not back away from the statements. Rather, henceforth it should bring to bear in its statements, speeches and other utterances a debate about where the Australian economy is headed post-mining boom. Infrastructure spending is one option but not the best. It is a stop-gap for growth but ultimately does not lead to new private investment. The only long-term solution is to lower the dollar.
There are three politically tenable options for the RBA to address the high currency:
- the jawbone
- print and give money to other central banks
- ask government for a Tobin tax on capital inflows
- use macroprudential tools to manage credit and slash interest rates
- cut property tax incentives and slash interest rates
But the bank won’t get any of these without again slapping the selfish children occupying Parliament House. The leadership and policy vacuum brought about by the election is an opportunity for the RBA to move forward on a sensible reform agenda of its own.
