The RBA has warned that risks are weighted to the downside. Annual GDP growth forecasts in June 2012 have been cut from 4.5 per cent to 4.0 per cent. Underlying inflation is tipped to ease to 2.5 per cent in June 2012, down from 3.0 per cent.
Given that interest rates are at the high end of the normal range there is a high chance of an additional rate cut at the February board meeting. However any further rate cuts will largely be dependent on Europe. “The Bank’s central scenario continues to be one in which the European authorities do enough to avert a disaster, but are not able to avoid periodic bouts of considerable uncertainty”.
The Reserve Banks central forecast assumes interest rates are unchanged over the forecasts period but given “A materialisation of the downside risks would likely be very disruptive for Europe and could result in a deep recession” it may result in the Reserve Bank cutting rates earlier than anticipated.
What does it all mean?
What a change three months can make. The mood and tone of the Reserve Bank has changed from one of optimism to considerably more downbeat. Economic growth forecasts have been downgraded substantially while inflation is now expected to hold comfortably within the 2-3 per cent target band over the forecasts period.
Interestingly the central bank has not highlighted much in the way of upside risks to growth forecasts. Rather the Reserve Bank goes one step further indicating the heightened downside risks to forecasts. The weakness in the domestic economy, slowdown in advanced economies and the threat that the European sovereign debt crisis gathers pace and adds to serious market volatility.
The Reserve Bank is clearly focussing a lot more attention on global conditions, particularly given the concerns surrounding Europe. In fact any further rate cut is likely to be as a result of the volatility in Europe. It is important to point out that the longer it takes to find a solution to the European debt crisis the more heighted the risks are for the global economy. In addition a further rate cut would help to shore up domestic confidence and ensure that monetary policy move to a more neutral setting.
The Reserve Bank has given further guidance about how to interpret “normal” or “neutral” monetary policy. The RBA noted that “Overall, the average rate on outstanding housing loans (fixed and variable) fell by about 9 basis points between the beginning of the year and the end of October, to be a little above its post-1996 average.”
Further the Bank said “The average rate on banks’ outstanding lending to large business fell by 16 basis points over the three months to the end of October, to be only slightly above its post-1996 average. The average rate on outstanding small business loans was little changed at 8.4 per cent, about 30 basis points above its post-1996 average.”
Overall it is clear that interest rates are still on the high side of the “neutral” or “normal” range, giving the Reserve Bank scope to cut rates in coming months.
The Reserve Bank has made it clear that there were various reasons behind the recent rate cut. The most important factor was a drop in the rate of inflation and significant cuts to inflation and economic growth forecasts. In addition, the Reserve Bank has highlighted the softer job market and weaker-than-expected wage growth. Then there has been the softness of the non-mining sector. And finally the outlook for the global economy has been downgraded, with significant risks surrounding the outlook for Europe. With interest rates still on the high side of “normal”, this means that the cash rate will be trimmed further either at or before the February Board meeting.
Key quotes and observations from the statement
RBA Forecasts:
“The near-term outlook for the overall non-mining economy remains subdued, with conditions likely to continue to diverge across industries.”
“Growth over the next few years is expected to be driven by mining-related activity, with below trend growth in the non-mining economy.”
“Growth in the wage price index is expected to remain around its current pace at a little less than 4 per cent. Together with a forecast improvement in productivity growth, this is expected to result in some moderation in growth of unit labour costs.”
“Overall, underlying inflation, excluding the impact of the introduction of a price on carbon, is expected to be consistent with the inflation target over the forecast period, although it is expected to pick up a little towards the end of the forecast period (second half of 2013), with a greater likelihood that it will be in the top half of the target range than in the bottom half.”
Risks
“For the global economy, the risks to the central forecast remain skewed to the downside, with the sovereign debt and banking problems in the euro area remaining the most prominent risks.”
“The possibility of a sharp economic deterioration in Europe represents a downside risk for the Australian economy.”
“the inflation forecast is conditional on some improvement in labour and multifactor productivity growth relative to the poor outcomes of the past 5 to 10 years, so that a continuation of the weak productivity performance would put pressure on domestic costs and inflation.”
New inflation estimates
“Using the updated 16th series weights together with the revised seasonal factors…suggest underlying inflation – abstracting from substitution bias – was running at 2¼–2½ per cent over the year to the June quarter, lower than earlier assessments of around 2½–2¾ per cent.”
Producer prices
“The September quarter producer price data point to some moderation in upstream inflation pressures. At the final stage of production (excluding oil), the year-ended rate of producer price inflation of 2.3 per cent was around the average pace seen over the past 12 years.”
Reduced wage pressures
“Business surveys and the Bank’s liaisons suggest a decline in momentum in labour costs growth in the September quarter, abstracting from some temporary strength in wage growth due to the award wage increase.”
Inflation over-stated?
“Taking the available measures together, the published data suggest that over the year to September underlying inflation was running a little below 2½ per cent…the pace of underlying inflation over the past year is complicated by the effect of substitution bias on the published data up to the June quarter, which means most of the available measures are likely to be slightly overstating underlying inflation over the year to September.”
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?
The data over the past week has painted a picture of a domestic economy that is still limping along. Building approvals remain soft, retail sales are showing encouraging signs but from a low base and the manufacturing and services sectors continue to contract. In addition the downside risks to the global economy have yet to subside.
More importantly inflation is not expected to be a major concern in the over the medium term, with underlying inflation only expected to get back to the top end of the Reserve Bank’s target band in late 2013. And as such the Reserve Bank has the option of moving to accommodative policy in the next few months. CommSec expects a further rate cut in February but if Europe fails to reach a solution to the debt problem it may result in the Reserve Bank cutting rates earlier than we anticipate.