The Reserve Bank has retired to the interest rate sidelines to assess the impact of the three rate cuts over 2012: “there are signs that easier conditions have been having some of the expected effects, and further effects can be expected over time.”
- The Reserve Bank has downgraded its economic growth forecast for December 2013 and June 2014 by a quarter of a per cent. There is no change to the inflation forecast.
- The Reserve Bank has become more hopeful: “the recent economic data have generally been a little more positive”.
What does it all mean?
- The Reserve Bank believes it has done enough for now. Rates were cut in May and June and the RBA followed this up with another rate cut in October. The RBA is of the view that the rate cuts are starting to work to lift growth. So for now it has retired to the sidelines to assess the impact of the last, and previous, rate cuts.
- Have rates bottomed? The optimists hope so; the pessimists are focussed on the problems in Europe and the “fiscal cliff” in the US. Given all the global risks, as well as the uncertainty of the domestic baton change from mining to non-mining sectors, we continue to pencil in another rate cut in February. Certainly a rate cut in December can be ruled out unless there is a disaster in Europe.
- Much will depend on the domestic baton change. With momentum from the mining sector set to ease, housing, personal spending and non-mining business spending will need to fill the void. And given the sluggish response by the economy to rate cuts so far, it is wise to remain cautious.
- The Reserve Bank believes that some slowing in wage growth is necessary. The next wage cost index data is due on Wednesday.
- The terms of trade has slumped 15 per cent from its highs but the RBA doesn’t expect the slide to continue, assuming some recovery in iron ore and coal prices “in line with other forecasters.” That positive outlook for income in Australia is another reason that the RBA saw fit to leave rates on hold on Tuesday.
Key quotes and observations from the statement
Opening sentence:
“Following weaker global economic conditions through the middle of the year, the recent economic data have generally been a little more positive.”
Rate cuts to boost growth:
“…there are signs that easier conditions have been having some of the expected effects, and further effects can be expected over time.”
Question marks on inflation:
“The outlook for inflation depends on whether soft demand in some parts of the economy helps to contain domestic cost pressures as the effects of the earlier rise in the exchange rate are now waning.”
But no change to inflation forecast
“Forecasts for inflation remain largely unchanged from the August Statement. Although the rate of inflation was a little higher than had earlier been expected, the effect of this on the inflation forecast is offset by the slightly weaker outlook for domestic economic activity and employment. This softer outlook is expected to help contain domestic inflationary pressures over the forecast period.”
Inflation outlook
“Underlying inflation is expected to be close to 2½ per cent over most of the forecast period. The combination of the carbon price effect and earlier volatility in fruit and vegetable prices is expected to see headline inflation rise above 3 per cent in year-ended terms in the first half of 2013, before declining to around 2½ per cent thereafter.”
Downside risks from global economy
“The risks to the global outlook remain tilted to the downside, primarily reflecting the risks associated with the banking and fiscal problems in the euro area.”
Cut to economic growth forecasts
“The outlook for the Australian economy is a little weaker than that presented in the August Statement. Over the year to June 2013, GDP growth is expected to be a little below 2¾ per cent before gradually picking up to just under 3 per cent over 2014. Most of this revision to the outlook is accounted for by a change in the profile for mining investment…”
Domestic economy prospects
“On the domestic front, the outlook for growth is sensitive to prospects for mining investment and the timing and extent of the anticipated recovery in both dwelling and business investment outside of the resource sector.”
More detail on domestic economic prospects
“Lower interest rates, rising rental yields and an improvement in conditions in the established housing market are expected to support rising dwelling investment. Business investment outside of the resource sector, which has been low, is likely to gradually recover over the next two years, though business surveys and liaison point to muted growth in the near term. Consumption is anticipated to grow at an around-trend pace over the forecast horizon. Public spending is expected to subtract from growth over 2012/13 owing to fiscal consolidation at state and federal levels.”
Bank funding costs
“Bank funding costs – relative to the cash rate – have risen by about 50 basis points over the past year, but are estimated to have been broadly unchanged since the previous Statement.”
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?
A December rate cut can be ruled out, barring foreign calamities. This is good news for investors, providing some certainty. The Reserve Bank will be closely watching Wednesday’s wage data. A higher-than-expected outcome would completely rule out a December rate cut and could call into question any further reductions.
The RBA has referred to the apparent pickup in underlying inflation in the September quarter. Clearly the RBA prefers quarterly underlying inflation growth of 0.7 per cent or below – there is a fine margin of tolerance.
Overall it is a calming and reassuring update from the Reserve Bank – nothing to scare the horses.