Downside risks to global economy prompted Reserve Bank to cut interest rates and minutes of the last Reserve Bank Board meeting confirm that policymakers were concerned about the strength of the global economy.
“Developments in Europe continued to pose downside risks to the global economy and, consequently, also to Australia. These risks had, if anything, increased though the timing and magnitude of any effects that might flow from them remained very difficult to predict”.
In contrast to the developments overseas, the RBA was modestly more upbeat about the domestic economy.
“The recent data on the domestic economy had been mixed but, on balance, had been slightly stronger than was the case around the middle of the year”.
Given that inflation was well contained the Reserve Bank felt it was best to take out some added insurance against the global economic backdrop by cutting interest rates for a second consecutive month.
The cautious recovery in economy-wide spending continued into November. The Commonwealth Bank Business Sales Indicator (BSI) rose by 0.3 per cent in trend terms in November after similar gains in October and September.
There was continued encouragement at a sectoral level with just four of the 20 industry sectors contracting in trend terms in November, down from five sectors in October.
What does it all mean?
It is clear that Board members have certainly become even more concerned about the global economic outlook, focusing on heightened “risks to the global economy and consequently also to Australia”. In fact the European debt crisis dominated discussion and was the key driver behind the second consecutive rate cut.
Board members discussed the sovereign debt issues and political in stability in Europe and the resulting volatility in sharemarkets. However what seemed to be even more troubling for Board members was the strain in bank funding across Europe. Members noted that “an increasing number of banks effectively shut off from new funding” and have scaled back lending – clearly increasing the risk of euro zone recession.
Interestingly while policymakers acknowledged the ongoing weakness in the housing sector. They were much more upbeat about the prospects for other sectors of the economy. In particular the minutes focussed on the strength in business investment – especially mining-related expenditure which was estimated to have grown by over 50 per cent over the past year. Even more encouragingly was the solid increases in investment in other sectors, including manufacturing.
The business sector is expected to drive growth over the coming year, and the strength in the latest investment plans puts Australia on a solid footing. However sentiment is a fragile commodity and the Reserve Bank is well aware that ongoing global growth concerns can have a rapid and detrimental impact on domestic condition if left unchecked. As such the Board decide to cut interest rate to take out an extra level of insurance against the global economic backdrop.
Overall, the Reserve Bank Board minutes paint an uncertain outlook for the global economy. It is clear that Board members don’t appear to be entirely comfortable at present. Global growth risks are weighed to the downside and as such CommSec believes the Reserve Bank will attempt to shore up domestic conditions by once again cutting rates in February.
The latest business sales index, confirms the sentiments echoed in the Reserve Bank Board minutes. Business activity has increased for three consecutive months, and there are clear signs that consumers are cautiously spending. Interestingly the cut in fixed and variable rates have prompted the pick-up in activity but it is of a low base.
In addition the big question will be whether there is enough momentum to carry the tentative recovery into the New Year, particularly as the Eurozone continues to grapple with its ongoing debt issues. Already consumer confidence levels have deteriorated despite the two rate cuts. And given that there hasn’t been any major decisive action by European governments, it’s very much a wait-and-see scenario.
What is the importance of the economic data?
The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.
The Commonwealth Bank Business Sales Indicator is obtained by tracking the value of credit and debit card transactions processed through Commonwealth Bank merchant facilities throughout Australia. The Business Sales Indicator is compiled monthly and covers 20 industry sectors and all Australian states and territories.
Credit and debit card transactions can be volatile on a month-to-month basis, affected by seasonal and irregular factors. To better gauge the direction and changes of spending across the economy, the Business Sales Indicator is tracked in trend terms.
The monthly Business Sales Indicator has been devised to provide a more timely assessment of spending trends in the economy. The main monthly indicator of spending in the economy is the Australian Bureau of Statistics’ (ABS) Retail Trade release. However these statistics cover just spending at retail establishments, and exclude spending at a raft of other businesses.
What are the implications for interest rates and investors?
The heightened risk of further weakness in the global economy certainly adds to the chance of a rate cut in coming months. The Reserve Bank Board has shifted rates to a more neutral setting however given the fragile nature of the global economy a shift to a more stimulatory stance is likely – especially given inflation is well contained.
