Two key factors include:

• the Chinese economy grew at a 9.1 per cent annual rate in the September quarter (consensus 9.3 per cent) down from 9.5 per cent in the previous quarter
• Chinese retail sales rose by 17.7 per cent on a year earlier and industrial output expanded 13.8 per cent – both results were well ahead of consensus forecasts.

What does it all mean?
The latest Reserve Bank minutes revealed that Board members have certainly watered down their views on inflation while also highlighting an array of headwinds facing the domestic economy. The European debt crisis dominated discussion and seems to be the key factor in the more open stance by policy makers when it comes to interest rates.

Overall, the Reserve Bank Board minutes paint a mixed picture of the Australian economy. The mining sector continues to dominate the growth outlook with a strong pipeline of investment, however conditions remained weak in the manufacturing, construction, wholesale and retail sectors. In addition Board members noted the softer housing market conditions and pick up in the rental vacancy rate across Australia. With all manner of diverging trends, Board members don’t appear to be entirely comfortable at present, wondering what the right move is at the current time.

Interestingly despite the recent global uncertainty and volatility in equity the Reserve Bank highlighted the strength of the Australian financial system. Making particular mention of the strength of the Australian banks and their ability to “withstand a further period of dislocation”. Ironically the conservatism been shown by consumers has ensured that domestic bank deposits remain healthy and continues to outpace lending growth.

The next batch of key inflation data (in late October) is likely to give central bank authorities a better picture of the inflation landscape. And while the inflation is off key focus, it is unlikely interest rates will be cut in November purely on a lower inflation environment. Rather the European sovereign debt crisis will be the dominating factor that will decide if interest rates are cut by 25 basis points on Melbourne cup day.
At first glance the latest slowdown in Chinese grow is concerning however the slow growth result was effectively induced by policymakers. In fact Chinese authorities have been actively tightening monetary policy over the past year and it is clear that the impact is now being felt across most parts of the economy.

Overall economic growth eased from 9.5 per cent down to 9.1 per cent – a two year low. However the data is backward looking and it should be remembered that the artificially induced slowdown was to combat inflation. And that seems to have paid dividends with inflation having peaked and likely to ease further in coming months.

More importantly the monthly economic indicators like industrial production and retail sales suggest that activity levels remain healthy. In effect the Chinese economy is bubbling along at a healthy pace and with more balanced growth and subdued inflation it is likely that policy makers will hold of from any further tightening measures. Keep in mind that if the economy slows too quickly authorities have ample tools available to turn on the stimulus tap.

Chinese data

• The Chinese economy grew at a 9.1 per cent annual rate in the September quarter (consensus 9.3 per cent) down from 9.5 per cent in the previous quarter. In constant price terms the Chinese economy grew at 2.3 per cent in the September quarter compared with the June quarter.
• Industrial output expanded at a 13.8 per cent annual pace in September, up from 13.5 per cent in August but above forecasts centred on 13.4 per cent. Production is still well off the highs of 20.7 per cent annual growth in January/February 2010.
• China’s urban fixed asset investment, such as spending on roads and power plants, grew at a 24.9 per cent annual pace in September, modestly above forecasts (24.8 per cent) and down from 25.0 per cent in August.
• Retail sales grew at 17.7 per cent annual rate in September, up from 17.0 per cent in August and above forecasts, centred on 16.9 per cent annual growth.

What are the implications for interest rates and investors?
The Reserve Bank Board has no need to jump either way on interest rates. But clearly if rates were to change in the short-term it would be down because of Europe debt crisis. The lack of momentum in the domestic economic and the heightened risk of further weakness in the global economy certainly adds to the chance of a rate cut in coming months.

The inflation data next week will be provide policymakers with a better picture of the economic landscape.

The self-induced slowdown in China is likely to be viewed negatively by markets, especially given the heightened global growth concerns driven by weakness in advanced economies. Chinese authorities are unlikely to tighten policy further in the current environment rather as inflation eases the potential for a shift in policy is probable – particularly if activity levels slow further.

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