• The Governor’s opening statement forecast that growth of 2‑3%pa is the most likely outcome for 2014/15 and inflation to remain consistent with the 2% to 3% target.
• Economic growth could be higher but there are significant forces restraining activity.
• There are signs of a pick‑up in non‑mining investment but investment intentions are mixed and dependent on the domestic growth outlook. Australians have become more risk averse since the GFC.
• The unemployment rate could stay near present levels and not fall significantly until 2016.
• The AUD remains high because of comparatively attractive yields in Australia. The USD is unusually weak. The RBA is not keen on market intervention to weaken the AUD.

RBA Governor Stevens and other officials appeared before the House Economics Committee in Brisbane this morning.  While the recent Statement on Monetary Policy (SMP) seemed to emphasise the downside risks to growth, the Governor was a touch more positive yesterday. The Governor was willing to contemplate some upside growth risks and noted that recent forecast changes didn’t really indicate a shift in thinking. Assistant Governor Kent muddied the waters a little by suggesting that the labour market outlook was little changed from earlier thinking as well, with a turning point in unemployment a little sooner than suggested in the SMP. The comment certainly suggests a reluctance to cut rates. But equally, the Governor made it clear that the RBA had not thought about raising rates lately.

The opening statement repeated some of the themes evident in the detailed media interviews and speeches in recent months. Namely, in terms of the world economy, growth is continuing at a “moderate pace”.  Importantly for Australia, major trading partner growth is running around its long‑run average rate.  China’s growth has been close to the official target of 7.5%.  The Governor noted the low volatility across global financial prices which is partly a reflection of the “exceptional” accommodative monetary policy that has been conducted across the world.

In terms of the Australian economy, GDP growth looks set to be between 2% and 3% in 2014/15 which is below its trend rate. The forces restraining growth are well known. The current fall in mining investment could be a bit larger than previously expected. The Australian dollar (AUD) remains relatively high, especially when compared to the level and direction of bulk commodity export prices. The USD, unusually, appears to be relatively weak given its firming growth and interest rate outlooks. Consumer spending is unlikely to lift significantly and could rise in line with modest income growth.

Offsetting these domestic weaknesses there is clear evidence of stronger activity in the interest‑rate‑sensitive areas like housing and other construction. The labour market reflects the conflicting forces in the real economy. The RBA expects the unemployment rate to stay high for a considerable period, until 2016. June quarter GDP growth is likely to be relatively weak compared to the strong QI figure.

The Governor’s testimony indicates that other issues, besides monetary policy, are holding growth back from its potential rate. Namely, a consistent and sustained lift in business confidence is required which would lead to higher non‑mining business investment. The shift to more risk aversion by households and business restrains economic growth.

The unemployment rate could stay near present levels until well into 2016. While forward indicators are positive there are other issues, like strong population growth, which impede a marked reduction in the unemployment rate.The highlights of the Q&A session include:

•  The high AUD reflects strong inflows of capital seeking higher yields, as well as a weak USD.
•  The RBA is keeping direct currency intervention as “part of the toolkit”.  So far, the Governor believes that it was been the “right call” not to intervene in the currency market.
•  Low wages growth is a product of elevated job concerns but it will help the economy adjust to a more competitive position and support jobs growth.
•  Productivity trends appear to be improving but more efforts are required to replicate the 1990s gains.
•  The RBA’s inflation target has a priority in policy deliberations over the setting of the cash rate.

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• There was no change to the RBA’s guidance about a period of stability in rate settings continuing.
• The June Board minutes look a bit more dated than usual given they predate the strong QI GDP result and the May jobs data.  Growth in 2014 looks like it will be around trend rather than “below trend”, as current RBA commentary suggests.
• The much‑anticipated pick up in non‑mining business capex now looks more definitive, given the latest capex survey.
• The RBA do not appear to be concerned with the recent sudden fall in sentiment.  Sharp movements in consumer sentiment do not necessarily mean a commensurate impact on household spending.
• We continue to expect the RBA to start raising interest rates in November.  Market expectations are focused around late 2015.

The June RBA Board minutes are probably a bit more dated that usual because the Board meeting pre‑dated the better than expected QI GDP data. The Board minutes note that GDP growth in 2014 is “expected to be below trend…rising gradually thereafter”.  However the strong QI print means that the next few GDP data outcomes will need to be quite low, if growth in 2014 is to be below trend.  This looks unlikely given recent data prints.  Overall, the minutes are more dovish than you would expect given the recent encouraging data.  There is still a bias to accentuate the downside risks.

The RBA’s comments around the labour market also seem to be down‑playing the positives in the recent data.  The RBA expect “moderate growth” in employment over the near‑term.   The Board meeting also predates the May employment data which showed that the unemployment rate was steady for the third month in a row at 5.8%.  If sustained, this means that the unemployment rate has already peaked, at 6.0% in January, a sooner and lower peak than the RBA was anticipating.

The RBA’s commentary on the capex environment has also shifted marginally given the latest release of the capex survey. Previously, the RBA said that a pick up in non‑mining investment was expected and in “prospect”.  The June minutes seem to be more definitive in the expected rise in non‑mining capex, noting that the latest capex survey was pointing to a “modest increase” in non‑mining investment.

The RBA noted that the 2014‑15 Federal Budget implied a narrowing in the deficit over the next two years that was slightly more than had been estimated in the 2013‑14 MYEFO, but in line with their own expectations.  Consumer sentiment has taken a hit over recent months, because of negativity around the Federal Budget and the potential impact on household finances.  The risk is that the decline in sentiment translates through to an actual impact on consumer spending.   The RBA commentary in the June minutes noted that sharp movements in consumer sentiment (such as the recent fall) do not necessarily translate into commensurate shifts in consumer spending.  A lessening in consumer job security fears is likely to also be lessening the impact of low sentiment on actual household spending activity.

The RBA’s comments on the Australian dollar are in line with the post‑meeting Statement, noting that “the exchange rate remained high by historical standards” given the decline in commodity prices recently.

We continue to expect the RBA to begin “normalising” monetary policy late in 2014, with a rate rise in November.  Markets are pricing in an interest rate hike in late 2015.  The risk is that a sustained stronger AUD could impact on the inflation trajectory and the growth transition and therefore the timing of any ultimate interest rate move.

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RBA Board minutes

• Triple A Credit rating: The Financial Review has reported in an “exclusive” today, that “Rating agency Standard and Poor’s is warning Australia’s prized AAA credit rating could be reviewed unless substantial cuts are made to the budget in coming years.”
• Consumer confidence falls: The Roy Morgan – ANZ weekly consumer confidence index fell by 3.2 per cent to 100.4 in the week to May 18. The index has fallen 14 per cent over the past four weeks.
• Reserve Bank Board minutes: Board members “considered that the current accommodative stance of policy was likely to be appropriate for some time yet.”

What does it all mean?

• All politicians must take heed of the warning by Standard and Poor’s on Australia’s credit rating. Unpalatable choices must be made to the structure of Australia’s pensions, benefits and support payments as well as Australia’s tax structure. The Budget must be passed and bi-partisan agreements are needed on future spending and taxing – that’s what Australians believe that politicians should be doing. No Australian wants the economy to get in the same predicament as a raft of European countries. Australia’s economy is in good shape through good stewardship by Reserve Bank, Federal Treasury and governments of all persuasion over the past 20 years. It is important it stays that way. As former state treasurers acknowledge, the GST rate has to be increased or the tax broadened in coming years to address fiscal challenges with the ageing population. It is important that community discussion on the topic starts now.
• The Reserve Bank believes that everything is going to plan. That is, domestic conditions “had evolved broadly in line with earlier expectations.” In short, there is no need to change monetary settings. Rates are set to remain unchanged for a few more months yet.
• Before the Federal Budget was handed down the Reserve Bank Board observed “Over 2014/15, GDP growth was expected to be a bit below trend, with the effects of monetary stimulus partly offset by the downturn in mining investment and planned fiscal consolidation.” In other words, monetary policy is balancing fiscal policy. We will have to wait for the June Reserve Bank Board meeting to find out whether there is any change in emphasis and magnitude of this balancing act.

What do the minutes and data reveal?

RBA Board minutes

• The full-text of the minutes can be found here.

The key final paragraph:

• “At recent meetings, the Board had judged that it was prudent to leave the cash rate unchanged. The expansionary setting of monetary policy continued to have the expected effects on economic activity. Notably, a sustained increase in dwelling investment was in prospect, consumption had strengthened a little and business conditions were around average levels. Recent developments had indicated that the economy had evolved broadly in line with earlier expectations, resulting in little change in the updated forecasts for activity and inflation. With growth in activity expected to pick up only gradually, and spare capacity in the labour market consequently remaining for some time, growth in domestic costs was forecast to remain contained, which would help to offset the ongoing effect on prices from the depreciation of the exchange rate over the past year. Given this outlook for the economy and the significant degree of monetary stimulus already in place to support economic activity, the Board considered that the current accommodative stance of policy was likely to be appropriate for some time yet.”
  • The Reserve Bank says that the domestic economy “had evolved broadly in line with earlier expectations.”
  • The Reserve Bank says “Inflation was consistent with the target and was forecast to remain so over the next couple of years.”

Consumer confidence

• The authors report: “The ANZ-Roy Morgan Consumer Confidence fell a further 3.2 per cent to 100.4 in the week ending 18 May, after the 2014-15 Commonwealth Budget was handed down. Consumer Confidence began weakening noticeably four weeks ago when some significant policies were leaked ahead of the Federal Budget’s release and is down a sharp 14 per cent since then; the steepest decline over a four week period since the series became weekly in October 2008.”
  • 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 next interest rate decision on June 4 will be super-important. Not because of some imminent change in rates, but because the Reserve Bank will be able to give its judgement on the fiscal contraction associated with the Federal Budget and the implications that this poses for interest rate settings.
  • CommSec remains hopeful that Budget measures will pass the Senate; that confidence levels will recover; and that economic momentum won’t be adversely affected. We continue to expect the first interest rate hike this cycle to be delivered either late in 2014 or early 2015.
  • The Aussie dollar has lost a bit of ground over the last 24 hours on the warning by Standard and Poor’s. The progression of the Budget through the Senate is a short-term obstacle for the Aussie dollar.
  • The Budget wrangling has upset consumer confidence. In a macro sense the Budget isn’t a major drag on the economy but the perception of hurt from Budget changes is impacting confidence to a greater extent that the reality of the actual decisions.

What is the importance of the report?

• 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.

What are the implications for interest rates and investors?

• The next interest rate decision on June 4 will be super-important. Not because of some imminent change in rates, but because the Reserve Bank will be able to give its judgement on the fiscal contraction associated with the Federal Budget and the implications that this poses for interest rate settings.
• CommSec remains hopeful that Budget measures will pass the Senate; that confidence levels will recover; and that economic momentum won’t be adversely affected. We continue to expect the first interest rate hike this cycle to be delivered either late in 2014 or early 2015.
• The Aussie dollar has lost a bit of ground over the last 24 hours on the warning by Standard and Poor’s. The progression of the Budget through the Senate is a short-term obstacle for the Aussie dollar.
• The Budget wrangling has upset consumer confidence. In a macro sense the Budget isn’t a major drag on the economy but the perception of hurt from Budget changes is impacting confidence to a greater extent that the reality of the actual decisions.

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Diana Mousina

The February Board minutes contained few surprises given the release of the quarterly Statement on Monetary Policy (SMP) at the beginning of February. The RBA’s “neutral” policy bias was again evident in the wording that “the most prudent course would likely be a period of stability in interest rates”.

The general tone in the February Board minutes is that the RBA is a little more relaxed about growth prospects (both at home and abroad) and a little less comfortable with the inflation outlook. The RBA noted that there are several possible explanations for the higher‑than‑expected QIV CPI. There could be an element of “noise” that occurs in economic data, the pass‑through from a lower exchange rate could be occurring more quickly than usual, the pass‑through from slow wages growth may be occurring more slowly than usual or there may be less spare capacity in the economy than previously thought. It is likely that it is a combination of all of these factors at work.

The RBA raised their inflation forecasts for 2014, as published in the SMP, with the June 2014 forecasts now exceeding the top side of the 2‑3% target band. The higher inflation forecasts are mainly due to the effects of a weaker AUD lifting import prices. The wage price data for QIV is released on Wednesday which will be an important guide for near‑term inflation risks. We are expecting quarterly wages growth around 0.7% (2.6%pa) which is slightly above market expectations of a 0.6% increase (2.5%pa).

We see the overall inflation risks as being skewed to the high end of the RBA’s new inflation forecast ranges. The RBA is still placing weight on the idea that slower wages growth will eventually produce a step down in what has proved to be very sticky domestic inflation rates. This step down is needed to offset higher import prices flowing from a lower Aussie dollar. But we suspect that the gap opening up between wages growth and domestic inflation is an indication of structural inflation drivers at work. From a policy perspective, the RBA has to run harder against the cyclical CPI component to offset the structural CPI pressures.

The RBA’s upwardly revised GDP forecasts come from the effects of a lower Aussie dollar stimulating activity in the traded goods and services sectors, a firmer housing construction outlook and clear signs of rising mining export volumes. The minutes noted that the central bank’s outlook for the labour market was little changed. This meeting occurred before the January employment data that saw the unemployment rate rising to a 10‑year high of 6.0%. The RBA has, however, been expecting a rise in the unemployment rate. The latest January data would not have caused the RBA to change their view on the labour market. The minutes also mentioned that labour market conditions lag economic growth. The various leading indicators were more positive for economic activity around the turn of the year which is positive for the labour market. The RBA also commented on the labour force participation rate, noting that “the ageing of the population accounted for around half of the decline in the participation rate over the past few years”.

On the global outlook, the RBA appears to be broadly comfortable with the global backdrop. The risks to global growth are evenly balanced and the Bank has notched up its forecasts for Australia’s trading partner growth to 4½% in 2014 and 4% in 2015. This is a small upgrade from previous forecasts and reflects improving conditions in the advanced economies.

Our forecasts have the RBA’s “period of stability” in interest rate settings extending through to late 2014 when we expect a modest tightening cycle to get underway.

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RBA Board minutes

• Reserve Bank Board minutes: Minutes of the November Board meeting confirm that the Reserve Bank is assessing developments before deciding the next move in interest rates. “it was prudent to hold the cash rate steady while continuing to gauge the effects, but not to close off the possibility of reducing it further should that be appropriate to support sustainable growth in economic activity, consistent with the inflation target.”
• Rate cuts at work: “There was mounting evidence that monetary policy was supporting activity in interest-sensitive sectors and asset values, and given the lags with which monetary policy operates, the stimulatory effects would likely continue coming through for some time.”
• Board members discuss uncomfortably high Aussie dollar: “The Australian dollar, while below its level earlier in the year, remained uncomfortably high. Members noted that a lower level of the exchange rate would likely be needed to achieve balanced growth in the economy”.

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