The Reserve Bank Governor has delivered the clearest message yet that the Central Bank has a strong degree of confidence in the outlook for the domestic economy. The tone and comments from the testimony is consistent with CommSec’s view that the cash rate will remain on hold until at least the May meeting.
While the European debt crisis is dominating attention the risks to the global economy have not materialised to the same extent as in 2008.
“the worst has not happened. Financial markets, while hardly brimming with confidence, have recovered somewhat over the past couple of months… High-frequency gauges of business conditions and confidence have stabilised over the past couple of months in Asia and North America, and even in Europe. We have not seen the very steep fall that we saw in all these indicators in late 2008.”
Interestingly the higher cost of wholesale funding and resulting out of cycle rate hikes by the domestic banks was anticipated by the Reserve Bank and was a key reason why interest rates were not cut in February.
“..the Board lower the cash rate by 50 basis points in the closing months of 2011. Perhaps surprisingly in the face of developments in wholesale funding costs, this was initially fully reflected in a reduction in most lending rates, though there has been a partial reversal of that recently.”
The Governor weighed in on the debate regarding the lack of consumer spending.
“Spending is growing in line with income, but people are spending their money differently. The retail sector is finding it has to adapt to this changed environment. Some other industries are struggling with the high exchange rate. Meanwhile certain service sectors are growing quite smartly.”
The key focus for the Reserve Bank is massaging the domestic economy through the resource investment boom – “which is still building and which will take the share of business investment in GDP to its highest level for 50 years” – while ensuring overall growth remains healthy and capacity constraints don’t add to inflationary pressures.
What does it all mean?
The Reserve Bank Governor has delivered his clearest statement yet that the domestic economy is holding up well despite an array of headwinds. The clear sense from today’s testimony to the Parliamentary Economics Committee is that Reserve Bank officials are extremely comfortable with current settings. Interest rate settings are around “normal” levels, and while the tame inflation outlook allows scope to cut interest rates the need to cut further has yet to materialise.
In addition the global economy has not fallen of a cliff and the “worst case scenario” has been avoided. The Governor made mention on numerous occasions that despite the ongoing European debt crisis indicators across the globe on business confidence and confidence have not recorded the steep fall that took place in 2008. The Governor took time to highlight the strengths of economies across the globe with particular focus on the cashed up balance sheets of US corporates and the likelihood that the sector “will at some point be able to start moving ahead more quickly”.
The pickup in the pace of hiring in the US and the more sustainable pace of Chinese growth were also discussed. Clearly the slowdown in China will be closely assessed given its importance to the Australian growth story. But the Governor was more comfortable that the Chinese slowdown had achieved the desired results and left Chinese authorities with more scope to move when it came to stimulating their economy.
The Reserve Bank remains quietly confident that the Australian economy is on a sustainable recovery path, but the key is ensuring that growth remains robust while inflation remains in-check. The focus for the central bank is clearly navigating the Australian economy through the resource investment boom which will “take the share of business investment in GDP to its highest level in 50 years.” The challenge for authorities is making sure that there is enough additional capacity in the economy to support the investment boom without significantly adding to inflationary pressures.
Interestingly the Governor made mention of the fact that the Reserve Bank was well aware of the rise in wholesale funding for the domestic banks, but to some degree he was surprised that the banks had passed on all of the rate cuts late last year. In effect the scenario was unsustainable and the resulting out of cycle rate hikes by banks was anticipated, and was a key strategic reason as to why the Reserve Bank did not cut interest rates in February. It is clear that the Central Bank is comfortable with current lending rates and at the same time conserving firepower to use in the future just in case downside risks gain traction.
While acknowledging that there has been a big change in household behaviour toward greater conservatism, the Governor clarified that “spending is growing in line with incomes”. In recent times there has been by a shift in consumers preference to spend on service rather than goods. Household balance sheets remain robust, and with the household savings ratio holding near a 25-year high any sustained improvement in confidence will prompt a pickup in spending. And while this makes it harder for retailers, from a broader economy-wide perspective it is not a bad thing that consumers are more conservative on spending and borrowing given the rise in margin pressures.
At present there are clear structural shifts that are taking place across the economy – in part due to the demand for Australian resources and higher exchange rate – and as the Governor highlighted while some sectors may contract other sectors will expand at a rapid pace. It is imperative for businesses to be fluid and adjust to the seismic shifts that are taking place and will define the economic landscape in years to come.
