• The recent floods and softer-than-expected economic data have caused the Reserve Bank to tinker with short-term forecasts, but the longer-term forecasts are unchanged.
• Given the weaker near term growth forecasts, CommSec has pushed out its rate call from April to May.
• The December 2010 GDP forecast has been slashed from 3.50 per cent to 2.75 per cent and the June 2011 forecast has been cut from 3.50 per cent to 3.25 per cent. Inflation forecasts have also been slashed to 2.25 per cent in December 2010 and June 2011.
• The rebuilding after the floods are assumed to boost GDP from 3.75 per cent to 4.25 per cent. There has been no change to underlying inflation forecasts from December 2011.

What does it all mean?

• The latest Monetary Policy statement highlights the Reserve Banks thinking on the impact of the recent natural disasters. The floods across three states, softer-thanexpected economic data and the latest cyclone have resulted in a profound downgrade on near term growth prospects for the Australian economy.
• While near term growth looks subdued, the Reserve Bank is certainly more optimistic about the second half of this year. The central bank believes that growth over the medium terms is likely to be spurred on by the considerable amount of rebuilding that will take place over the second half of 2011. In fact December 2011 growth forecasts have been upped by half a percent to 4.25 per cent. And despite robust growth the icing on the cake is that inflation will remain contained well into 2013.
• The bottom line is that interest rates are going nowhere for now. The pattern of growth will change in response to the floods but there is no change to inflation in the medium term.In fact near-term inflation is lower than the Reserve Bank had initially expected.

• Interest rates look to be on hold for the next two months. The March quarter inflation data to be released in late April in the next signpost to watch. We continue to expect higher rates in the second half of 2011 as all growth cylinders start to fire. The cash rate is expected to be 5.50 per cent by end year.
• When the floods struck there were some wild forecasts by economists about what the impact would be on economic growth and inflation. The RBA has set the record straight, expecting short-term negative effects on growth to be broadly cancelled out by longer-term rebuilding activity.
• In net terms, the Reserve Bank believes that the floods will reduce economic growth in 2010/11 by around half a percentage point. In dollar terms, that is around $6.5 billion. The boost to GDP in the two years from June 2011 is estimated at quarter of a percentage point a quarter. Overall by mid 2013, the RBA is assuming that GDP will be little changed compared with the pre-flood baseline.
• Interestingly given the recent debate on the impact of on online retailing, the Reserve Bank has waded into the discussion noting that online retailing effectively makes up a very small component of the overall retail picture. In fact the Reserve Bank believes that while online retailing has been growing at a rapid pace it is equivalent to around 3 per cent of total household consumption. Clearly calls for a GST to be applied to online retailing are premature given the costs of accounting and collecting the revenue.
• The labour market was once again in focus given the stronger than expected employment growth over 2010. And the results may surprise some people especially given the Reserve Bank expects employment growth to slow. And coupled with a pickup in productivity this should ensure that the unemployment rate will ease gently over time – a result that should temper some of the expectations for rate hikes.

Key quotes and observations from the statement

• Economic growth forecasts: “GDP is expected to grow by around 4¼ per cent over 2011, boosted by the recovery in coal production from the effect of the floods. Growth is expected to remain at an above-average pace of around 3¾–4 per cent over the rest of the forecast period. In year-average terms, GDP is forecast to grow by 2¾ per cent in 2010/11, 4¼ per cent in 2011/12 and 4 per cent in 2012/13.”
• Inflation outlook: “The medium-term outlook for inflation is broadly unchanged. In underlying terms, inflation is expected to be around 2½ per cent later in 2011, before picking up gradually to 3 per cent by late 2012. In the next few quarters, year-ended CPI inflation is likely to remain above underlying inflation, largely due to the effects of the earlier increase in tobacco excise and significant increases in the prices of utilities.”
• Economic outlook: “The Bank’s medium-term outlook for the Australian economy remains broadly unchanged from that in the November Statement, although the floods in eastern Australia will have a temporary effect on GDP outcomes over coming quarters.”
• Medium-term outlook still strong: “With GDP growth expected to be above trend over much of the forecast horizon, pressures on capacity are likely to emerge in parts of the economy as the structural adjustment to the large change in relative prices takes place.”
• Flood impact on inflation: “In terms of headline inflation, the floods are expected to add around ¼ percentage point to CPI inflation in the March quarter – mainly through higher fruit and vegetable prices – with much of this being reversed in the following quarter.”
• Flood impact on economic growth: “the recent floods will have a material effect on the near term profile of Economic Insights Reserve Bank signals rates on hold GDP, with growth in the December and March quarters notably lower than would otherwise have been the case, followed by a strong recovery in the June quarter as coal production picks up and the rebuilding effort gets under way. Over the four quarters to December 2011, GDP is expected to increase by 4¼ per cent. This is higher than was expected at the time of the November Statement, but this revision reflects the lower starting point as a result of the flooding in December 2010.”

• Weak household sector: “Nominal retail sales remain weak and retailers report that consumers continue to be very value-conscious. Housing credit growth is also subdued compared with the standards of previous years, although it is only a little below the pace of growth in household income. Nationwide measures of housing prices have been broadly flat since mid 2010. Overall, many households appear to be taking a more cautious approach to their finances than was the case in earlier years. With business investment expected to grow strongly, this more cautious approach, if it is maintained, would reduce the pressures on capacity that are likely to arise over the period ahead.”
• Job market isn’t overly tight: “Businesses are reporting that the labour market has tightened, although most are not experiencing significant difficulties in hiring employees. The labour market appears tightest for some miningrelated and skilled occupations.”
• Flood impact on GDP: “the Bank’s preliminary estimate – made prior to an assessment of the impact of Cyclone Yasi – is that GDP growth in each of the December and March quarters could be around ½ percentage point lower than what it otherwise would have been, with the biggest impact arising from the disruption to coal production in Queensland. However, assuming no further significant weather disruptions, the recovery in coal production, bounce-back in delayed private spending and commencement of replacement and repair spending are estimated to bring the level of June quarter GDP back close to its pre-flood forecast. This profile implies a reduction in the level of GDP in 2010/11 as a whole of close to ½ per cent compared with the outlook immediately prior.”
• Flood impact on inflation: “Overall, price increases related to the floods could contribute around ¼ percentage point to headline inflation in the March quarter, although much of this is likely to be reversed fairly quickly. The effect on underlying inflation would be lower.
• Flood impact on insurers & banks: “Australia’s general insurance industry is well placed to cope with a large increase in claims expenses.” In terms of the banking sector the RBA said: “The impact of the floods on the banking sector is also likely to be limited.”
• Online spending: “There are, however, no official data on the total value of online purchases, although a range of industry estimates suggest that these purchases are equivalent to around 3 per cent of household consumption. Industry reports and the Bank’s liaison also suggest that online purchases have grown strongly over recent years.”
• Growth of online spending: “Since 2005, the value of online spending on debit and credit cards has grown at an average annual rate of more than 15 per cent, although over the past year there has been little change in this type of spending.”
• Share of online spending: “online payments account for only around 10 per cent of total domestic payments on credit and debit cards.”
• International electronic purchases: “In total, the value of international electronic purchases has grown at an average rate of 15½ per cent since 2005, which is faster than the growth in electronic domestic purchases of 10 per cent. It is likely that much of this growth in international purchases reflects the significant increase in the number of Australians travelling overseas.”

What is the importance of the economic data?

• The Reserve Bank releases its Statement on Monetary Policy each quarter. The Statement is the Reserve Bank’s assessment of economic and financial conditions and also contains the latest inflation views. The Statement is crucial is assessing the short-term outlook for interest rates.

What are the implications for interest rates and investors?

• Rates are effectively on hold for the next couple of month. There is no pressing need for the RBA to change rates either up or down. Price pressures are contained, growth while sluggish in the near term is likely to pick up pace in the second half of the year. And even the job market is looking better with firms having little difficulty in finding staff.

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