Anecdotal evidence suggests that smaller retailers are finding that consumers have become tightfisted.

Australia’s economy pleasantly surprised most analysts when it grew at its fastest pace in two years over the March quarter, to sustain an expansion that dates to the last quarter of 1991.[1]

Increased export sales, more household spending and greater investment in dwellings drove an economic expansion of 1.1% in the March quarter, a report in June showed. Over the 12 months to March this year, Australia’s economy expanded 3.5%, a respectable pace at any time.[2]

The spurt in exports came largely from the mining sector even though the prices of some materials such as iron ore have dropped on lower demand from China. Mining exports are rising because all the investment in the mining sector over the past decade expanded production enough to compensate for falling prices. Low interest rates explain the increases in housing investment and consumer spending.

The Reserve Bank of Australia looks set to hold the cash rate at a record low 2.5% for a while yet as inflation appears tame. The boost in mining capacity, including the onset of sales from new LNG plants, points to higher export sales. This means these two favourable conditions will be in place to help the economy expand in coming quarters. Further help for the economy is that unemployment is still low, holding at 5.8% in May, which is not far off levels regarded as full-employment. Rising housing prices and ever-climbing stock markets are making people feel wealthier. The economic news from the rest of the world is largely the same as it was at the start of the year. What could go wrong?

Well, something has. Retailers such as Pacific Brands, the maker of Bonds clothing and Sheridan bed linen, the Reject Shop, which operates discount stores, and Super Retail, which owns leisure specialty stores such as Rebel, in June issued warnings that sales have dropped so much in recent weeks that their earnings will be hit. It’s not just the big companies that are complaining. Anecdotal evidence suggests that smaller retailers around the country are finding that consumers have become tightfisted.

Some retailers are citing warmer-than-usual weather on the east coast for their predicament. (The way life works we don’t tend to hear from the retailers that benefited from the hotter May.) But many, if not nearly all, of the stressed retailers are blaming something else; the federal government budget brought down in May.

The mixture of touted spending cuts, tax increases, mooted charges for visiting a doctor and possibly higher tertiary education fees, the political brawl over fairness, inequality, allegations of broken promises and a budget emergency seems to have spooked people.

Other evidence that the budget made people jumpy was a large plunge in the consumer confidence pulse that is taken each month by Westpac Banking and the Melbourne Institute. The index they compile by surveying people fell 6.8% in May from April to 92.9, the lowest since August 2011 where 100 is the neutral level. Bill Evans, Westpac’s chief economist, said the people’s responses to the questionnaire were “clearly indicating an unfavourable response to the recent federal budget”.[3] Ominously, there was no rebound in June, even if the index did edge up to 0.2%, for June’s result still leaves the index floundering 6.6% lower than April’s level and 15.6% below the post-election high in November last year.[4]

The Reserve Bank added to concerns about declining consumer demand when it said in June that “growth of the nominal value of sales had slowed over the three months to April, and the bank’s retail liaison suggested that growth had moderated further in May.”[5] (Retail liaison is the central bank’s jargon for its discussions with retailers.)

The budget, as a document for managing the economy over the next 12 months, carried to punch against economic growth because few of its higher charges, increased taxes and spending cuts take immediate effect. But the thought of likely future stress on household budgets has dampened people’s willingness to spend as robustly as before.

Consumer sentiment has plunged for a variety of reasons in the past without damaging the economy. People can still spend when they are worried about the outlook or move on from these doubts and confidence bounces back. Retail sales are only a partial guide to consumer spending as they only amounts to about 20% to 25% of GDP. Perhaps household spending outside the retail sector – on items from school fees to medical bills that comprise about 25% to 30% of output – has picked up. (Total household consumption sits at about 50% of GDP. The breakdown between sales at retail stores and other consumer spending is murky.)

The danger is, though, that if retail spending is sluggish and consumer sentiment is poor then economic growth will be hampered. For it’s hard for exports, business investment or government spending to compensate for the shortfall in consumer spending.

It’s a while off before we find out how the economy performed for the just-ended June quarter. The verdict on the evidence so far mustered is unlikely to pleasantly surprise.

Financial information comes from Bloomberg unless stated otherwise.

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• 

  Interest rates holding steady

  The Reserve Bank Board has left the official cash rate at 2.75 per cent for the second straight month. In May the RBA cut the cash rate by 25 basis points to the lowest levels recorded in 53 years. The next RBA Board meeting is on August 6 2013.

• The accompanying interest rate statement was once again short at just 360 words. Basically the Reserve Bank left rates on hold cause the falling Australian dollar is helping to rebalance the economy and stimulate activity. In addition rates are low enough to boost economic growth. But if the economy continues to lag and inflation stays low, the Reserve Bank has vowed to cut rates further.

What does it all mean?

• Economists were in agreement that rates wouldn’t fall this month. And financial market pricing suggested only a 18 per cent chance of a rate cut. And indeed this month there were no surprises. The continued improvement in the health of the US economy, together with a weaker Aussie dollar, provided sufficient reasons for the Reserve Bank to keep rates on hold for this month. But the Reserve Bank warned last month that it would do what it takes to restore growth, and indeed the central bank still has plenty of ammunition left.
• One of the key drivers of keeping interest rates on hold concerns the Aussie dollar. The Aussie dollar has fallen by over 12 per cent in the past two months and it is already starting to have a significant impact in rebalancing the economy and supporting activity. The latest manufacturing reading has highlighted that the sector does seem to be on a recovery path as exports receive a boost from the cheaper Aussie dollar. In addition Aussie farmers have been enjoying historically high prices global prices which will result in higher incomes given the falling currency. In fact all manner of exports will benefit from recent currency weakness.
• Interest rates are sufficiently low to get consumers and businesses borrowing again. But the “new conservatism” continues with people more comfortable about using their own funds to make purchases. And the question that needs to be asked is would another rate cut make all the difference to activity levels? Unlikely. The long drawn out Federal election campaign is the main driver of uncertainty, and most businesses want the election out of the road before committing to major new spending or investment. The Reserve Bank is likely to take a cautious approach to further rate cuts, particularly given that interest rate sensitive areas of the economy, like housing are starting to respond to low rate settings and in addition confidence levels should rebound after the election.

Interest rate decision and past cycles

• The Reserve Bank Board has left the cash rate at a 53-year low of 2.75 per cent. The previous rate cuts were in May 2013 (25 basis points), December 2012 (25 basis points), October 2012 (25 basis points), June 2012 (25 basis points), May 2012 (50 basis points) and November and December 2011 (each by 25 basis points). Prior to those moves the Reserve Bank had previously lifted rates seven times from October 2009 to November 2010 – a total of 1.75 percentage points, from 3.00 per cent to 4.75 per cent.
• In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. In the previous rate-cutting cycle the cash rate fell to 4.25 per cent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
• The Reserve Bank looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the variable housing rates of major banks are around 6.20 per cent, below the long-term average or “normal” rate of 7.20 per cent but still modestly above the 41-year low of 5.75 per cent recorded in April-May 2009.
• What are the implications of today’s decision?
• ·Interest rate stability is a good thing. Many Aussies are worried when rates are cut from already super-low levels, as shown by the poor response of consumer and business surveys after the May rate cut. If rates are cut from high levels, the move provides relief. Rates that are cut from low levels raise questions about the true state of the economy.
• Certainly there is more activity in the housing market at present, but the response has been more by investors rather than owner-occupiers. Not only do analysts need to consider the environment, but also the different reaction funds of demographic groups, from Generation Y to baby boomers.
• The Reserve Bank has made mention in recent times that only “some” of the scope to ease policy was used, keeping some in reserve. The Reserve Bank has kept the easing bias firmly in place. So we continue to pencil in the risk of another rate cut in August after the inflation data released in late July. Of course if the Federal government looks at early timing for the election this would shift our view.
• The statement from the June meeting is on the right; the statement from today’s July 2013 meeting is on the left. Emphasis has been added to significant changes in wording in the recent statement.

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What do the Minutes reveal?

• “Overall, recent data suggested that interest-sensitive parts of the economy were responding to the historically low levels of lending rates and it remained likely that this had further to run. At the same time, the factors weighing on the economy – including the high exchange rate, the waning growth of mining investment, and fiscal consolidation – were likely to persist. The key issues were what the balance of these factors would turn out to be.”
• “With growth forecast to be a little below trend in 2013, and inflation close to target, members judged that it was appropriate for the stance of policy to be accommodative. The outlook for inflation, as currently assessed, would provide scope for further easing should that be necessary to support demand. At this meeting, the Board’s judgement remained that, on the information currently to hand, the most prudent course was to hold rates steady and to continue to assess developments over the period ahead.”
• Job market mixed: “Firms in some industries had shown a willingness to add to their workforce – including in the construction industry – and recent labour market data had been mixed.”
• Housing outlook: “Over the past few months, housing loan approvals had picked up for both owner-occupiers and investors, and stronger conditions in the established housing market more generally were expected to support moderate growth of dwelling investment this year.”
• Stronger consumption: “Recent indicators suggested that growth of consumption had increased over recent months after a softer December quarter. The value of retail sales picked up strongly in January and the Bank’s liaison pointed to further growth in February and March.”
• Investment insights: “Information from the Bank’s liaison indicated some willingness on the part of firms outside the mining sector to increase investment spending, especially on information technology assets and systems.”

What is the importance of the economic data?
The Reserve Bank releases minutes of the monthly Board meeting a fortnight after the event. The minutes provide insight into central bank thinking on rate settings.

What does it all mean?

• The Reserve Bank couldn’t say it any better. Interest rate settings are on hold. If rates were to move in any direction it is more likely to be down. But the RBA isn’t laying the groundwork for a major easing of monetary policy. To the contrary – the RBA believes that low rates are working to boost growth.
• The Reserve Bank has plenty of ammunition to use to boost growth if it needs to with the cash rate at 3 per cent and inflation expected to be in the target band.
• CommSec expects the Reserve Bank to stay on the interest rate sidelines.

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• Household conservatism is encouraged – “Ongoing consolidation of household balance sheets would be desirable from a financial stability perspective”.
• The RBA has provided special sections in the report dealing with the funding composition of banks and households mortgage repayment buffers.

What does it all mean?
The Financial Stability Review usually is a straight-forward document with few controversial issues raised. But in the latest report the Reserve Bank has been uncharacteristically forthright, warning banks against the temptation of easing lending standards too far.

The RBA notes that profit growth has slowed, credit growth is lower and there are higher funding costs. In this environment a financial intermediary may be tempted to ease lending standards to boost lending and profit growth. The RBA notes that there will be challenges in the months ahead to resist the temptation to ease lending standards too far “in the pursuit of unrealistic profit expectations.”

A number of businesses will be disappointed by the RBA warning to banks. Small businesses, and especially borrowers in the real estate segment, believe that banks are being too conservative in lending practices. The challenge for banks is to achieve an appropriate balance between risk and return that pleases the regulators and the general public.

And any thoughts that the RBA is concerned with the extent of consumer conservatism have been dispelled. The RBA notes that the “consolidation of household balance sheets” remains a positive development from a big picture perspective. Again, sections of the business community will be disappointed, especially retailers.

There is plenty of comfort in the report as well with the RBA noting that 15 per cent of borrowers are ahead in repayments by two years or more. Further, in terms of bank funding, dependence on domestic deposits is now similar to other advanced economies.

In addition the central bank also noted the pickup in appetite for debt by the corporate sector – which has grown by 6½ per cent in annualised terms over the six months to July after declining for much of the previous three years. No doubt the sharp fall in fixed and variable rates is enticing businesses to once again look at funding to accelerate investment plans.

What is the importance of the economic data?
The Financial Stability Review is published by the Reserve Bank every six months. The report is basically a health check on the financial sector but it also assesses the state of household and business balance sheets.

What are the implications for interest rates and investors?
The Reserve Bank doesn’t want banks to ease lending standards to give a boost to economic growth. The RBA is effectively saying that if there is an easing to be done, it is by us. The door certainly remains open to a further rate cut. We favour a move in November but can’t rule out some stimulus being delivered next week.

The document also highlighted the super-conservative financial practices by consumers and businesses and the ongoing deleveraging that is taking place. Interestingly the cautious nature of Aussie households has not only resulted in paying down debt at a faster pace, but also a shift away from riskier asset classes. In fact the report details the share of households’ financial assets held directly in equities (outside superannuation) has roughly halved, from 18 per cent in 2007 to 8½ per cent in March 2012.

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• The variable housing rate is applying modest stimulus to the economy at present at 6.85 per cent, below the 15-year average of 7.20 per cent. The next RBA Board meeting is on October 2 2012.
• The Reserve Bank focussed on global developments: Regarding China “some recent indicators have been weaker, which has added to uncertainty about near-term growth. Around Asia generally, growth is being dampened by the more moderate Chinese expansion and the weakness in Europe.”

What does it all mean?
It is clear that the Reserve Bank is happy to remain on the interest rate sidelines – at least for the time being. Policymakers seem comfortable with domestic economic conditions but continue to watch the global situation carefully. Europe, the US and Asia have slowed and the central bank seems particularly focused on the slowdown in China, given its importance to Australia’s growth profile.

There are yet to be credible signs that of a turnaround in Chinese activity. In fact the latest manufacturing data suggested that the contraction in exports continues to affect the growth profile of the biggest consumer of Australian raw materials. Interestingly the statement accompanying the “no change” decision highlighted that Board members discussed the sharp slide in “key natural resources”. And looking forward if a further severe decline in the commodity prices took place the Reserve Bank would reassess its economic outlook given a less robust boost to incomes.

At present, the fact that the Reserve Bank is content to stay on the interest rate sidelines is a mark of confidence in current settings. Not only have interest rates been lowered in recent months but there have also been government handouts and tax cuts. And it takes time for these stimulus measures to work its way through the economy.

Despite the fact that interest rate have remained unchanged for three consecutive months it is unlikely to be the end of the interest rate cutting profile. In fact market pricing is now for a full 1 per cent worth of rate cuts over the next 12 months. And one could argue that there are plenty of domestic reasons for the Reserve Bank to be cutting rates in the next couple of months – particularly given the slide in the latest round of retail sales figures and ongoing weakness in job advertisements.

However the Reserve Bank still holds to the central view that the longer-term outlook for the Australian economy remains sounds and the latest upgrade to domestic growth forecasts in the monetary policy statement confirmed that view. As such, while rate cuts are still likely it will be a much more considered response.

CommSec believes that more rate cuts are possible over coming months and we have pencilled in another quarter per cent rate cut in November – after the next round of inflation data. Hopefully this rate cut won’t be required. That is, European officials act with urgency to stabilise financial markets, the US economic recovery gathers pace, the Chinese economy lifts and Aussie consumer confidence improves providing a catalyst to spend, invest and borrow again. But a lot does have to go right for this scenario to take place.

Interest rate decision and past cycles
The Reserve Bank Board has left the cash rate at 3.50 per cent. The previous rate cuts were in June (25 basis points), May (50 basis points) and November and December 2011 (each by 25 basis points). Prior to those moves the Reserve Bank had previously lifted rates seven times from October 2009 to November 2010 – a total of 1.75 percentage points, from 3.00 per cent to 4.75 per cent.

In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. In the previous rate-cutting cycle the cash rate fell to 4.25 per cent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.

The Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the variable housing rates of major banks are around 6.85 per cent, below the long-term average or “normal” rate of 7.20 per cent. The RBA notes that “interest rates for borrowers (are) a little below their medium-term averages.” In other words stimulus is still very modest.

What are the implications of today’s decision?
The fiscal and monetary stimulus applied over the last few months will gradually work its way through the economy in coming months, however given the downside risk to global growth it likely that policymakers will maintain an easing bias. CommSec expects rates to be cut once more within the next three months.

For some consumers and businesses confidence is generated when the Reserve Bank Board decides to cut interest rates. But the fact that the Reserve Bank didn’t cut rates this month arguably should inspire even greater confidence. Inflation is below 2 per cent, unemployment is near 5 per cent, and economic growth is the fastest of advanced nations. There is plenty to inspire confidence.

But make no mistake; the Reserve Bank is well prepared to cut rates again if necessary. The global outlook is still uncertain. At the same time the Aussie dollar remains high despite “the weaker global outlook”.

And inflation remains low – although the Reserve Bank warns that growth in domestic costs need to keep moderating. Certainly our cash rate is still high compared with other nations at 3.50 per cent, so there is plenty of ammunition available.

The Reserve Bank seems to be waiting on the next round of inflation data which is released at the end of October before deciding on further rate cuts. A low inflation reading would allow policymakers to feel more comfortable about cutting rates in coming months, if they deem it is necessary.

Retailers are likely to find trading condition tough in the short-term an improvement in confidence will be required to see a sustained shift in spending patterns.

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The variable housing rate is applying modest stimulus to the economy at present at 6.85 per cent, below the 15-year average of 7.20 per cent. The next RBA Board meeting is on 4 September 2012.

The Reserve Bank exhibits a quiet confidence: home prices have firmed “a little”, business lending is recording the “strongest growth for several years” but “the exchange rate, however, has remained high, despite the observed decline in the terms of trade and the weaker global outlook.”

What does it all mean?
The Reserve Bank is clearly now in “wait and see” mode. The European and Chinese economies slowed in late 2011 and early 2012 while the US recovery proceeded slowly. As a result the Reserve Bank cut the cash rate by 1.25 percentage points in the space of eight months.

Now the US recovery is proceeding but “at only a modest pace”. “China’s growth has moderated to a more sustainable pace, but does not appear to be slowing further.” But “the most significant area of weakness continues to be Europe, where economic activity has been contracting and policymakers confront the very difficult task of seeking to put both bank and sovereign balance sheets onto a sound footing, while promoting conditions for improved long-term growth.” So the Reserve Bank is maintaining a watchful stance.

But make no mistake; the Reserve Bank is well prepared to cut rates again if necessary. The global outlook is still uncertain. At the same time the Aussie dollar remains high despite “the weaker global outlook”. And inflation remains low – although the Reserve Bank warns that growth in domestic costs need to keep moderating. Certainly our cash rate is still high compared with other nations at 3.50 per cent, so there is plenty of ammunition available.

A key “hot button” issue is the Aussie dollar which is relatively high, and arguably over-valued. If the Aussie was to keep rising, under-pinned by its newly acquired “safe-haven” status, then the Reserve Bank will be tempted to cut rates again. The central bank warned early in the year that currency strength could lead to a rate response, so the issue is clearly on the radar screen.

At present, the fact that the Reserve Bank is content to stay on the interest rate sidelines is a mark of confidence in current settings. Not only have interest rates been lowered in recent months but there have also been government handouts and petrol prices have eased from highs.

CommSec believes that more rate cuts are possible over coming months and we have pencilled in another quarter per cent rate cut by the end of the year. Hopefully this rate cut won’t be required. That is, European officials act with urgency to stabilise financial markets, the US economic recovery gathers pace, the Chinese economy lifts and Aussie consumers maintain confidence to spend, invest and borrow again.

Interest rate decision and past cycles
The Reserve Bank Board has left the cash rate at 3.50 per cent. The previous rate cuts were in June (25 basis points), May (50 basis points) and November and December 2011 (each by 25 basis points). Prior to those moves the Reserve Bank had previously lifted rates seven times from October 2009 to November 2010 – a total of 1.75 percentage points, from 3.00 per cent to 4.75 per cent.

In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. In the previous rate-cutting cycle the cash rate fell to 4.25 per cent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.

The Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the variable housing rates of major banks are around 6.85 per cent, below the long-term average or “normal” rate of 7.20 per cent. The RBA notes that “interest rates for borrowers (are) a little below their medium-term averages.” In other words stimulus is still very modest.

What are the implications of today’s decision?
For some consumers and businesses confidence is generated when the Reserve Bank Board decides to cut interest rates. But the fact that the Reserve Bank didn’t cut rates this month arguably should inspire even greater confidence. Inflation is below 2 per cent, unemployment is near 5 per cent, economic growth is the fastest of advanced nations and the Federal budget deficit is continuing to contract. There is plenty to inspire confidence.

But the Reserve Bank will need to be mindful of the contractionary effects of the Australian dollar. The fact that interest rates are on hold may result in the Aussie dollar gravitating higher. Reserve Bank officials undertook subtle jawboning on the currency earlier in the year and a repeat dose may be necessary.

Retailers have reason to be hopeful. Consumers are starting to spend again, buoyed by an array of stimulus measures. The stimulus effects will gradually wear off but if they are replaced by a lift in consumer confidence, then the recovery in spending can continue.

With economic conditions showing signs of stabilising, investors now need to start thinking about longer-term returns rather than focussing on short-term capital preservation.

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• ECB President Draghi basically confirmed a plan to buy bonds in countries such as Italy and Spain providing they apply to the European Financial Stability Facility for assistance and sign a Memorandum of Understanding committing them to reforms. Such action will effectively involve the EFSF buying bonds in the primary market and the ECB buying bonds in the secondary market until yields fall to more sustainable levels. Markets were disappointed that the ECB is not acting immediately. However, it would be wrong to underestimate the ECB’s commitment to preserving the euro. There are a number of points to note. First, Mario Draghi has a track record of delivering despite initial scepticism as was seen last year with the provision of cheap funding for banks. Second, the proposed approach has two benefits: by acting with the EFSF the ECB can allay its fear that it is providing “money for nothing” as it will be conditional on MoUs being signed; and the ECB can effectively boost the firepower of the EFSF. Third, Draghi has made three very positive comments in saying that investor concerns about the ECB ranking senior to private investors will be addressed, that the ECB will consider further non-standard easing measures and that any bond buying may not be sterilised opening the door to quantitative easing. Fourthly, while the Bundesbank is opposed to any ECB bond buying, this is unlikely to be a problem as its majority rules at the ECB. Finally, there’s an element of win-win here – either Spanish and Italian bond yields settle down or if they don’t they will apply for assistance and bond buying by the EFSF and ECB will force them down. So it may all take longer than would be ideal but its all heading in the right direction.
• The US Federal Reserve has clearly signalled it will provide more monetary easing if the pace of growth doesn’t improve. We expect QE3 will be introduced after its next meeting in mid September. In the meantime watch payroll releases, retail sales and Ben Bernanke’s address August 31 at the Jackson Hole central bankers’ conference. Again there’s an element of win-win here – either US jobs growth picks up or the Fed does QE3.
• Should the RBA intervene to limit the $A? While a case can be made for currency intervention if temporary “hot money” capital flows have pushed a currency far away from fair value, its far from clear that this is the case with the $A. We don’t know whether the capital inflows driving the $A are temporary or permanent, allowing for the still high level of the terms of trade the $A is unlikely to be far from fair value, in any case fair value levels are far from clear and its well known from the period before the December 1983 $A float that if we try to control the $A we lose control of domestic interest rates. In fact I would argue that intervention to limit the $A risks sliding us back into the economic mediocrity that prevailed prior to the currency being floated. Strong countries have strong currencies – we should learn to live with it and focus on boosting productivity.

Major global economic releases and implications

• US economic data remained mixed with the ISM business conditions index recovering only slightly in July, other business surveys mostly coming in on the soft side and weekly retail sales data remaining soft. Against this though, consumer confidence rose in July, house price data continues to point to a housing recovery and employment readings were a bit better than expected. The overall picture remains of an economy growing at a sub-par rate but not collapsing. US June quarter profit results are still coming in better than feared with 68% beating earnings expectations and 63% beating on revenue. Corporate guidance has been soft though.
• European data remained weak with final PMI business conditions indicators for July and various economic sentiment readings pointing to ongoing recession the severity of which was highlighted by news that the Euro-zones unemployment rate has increased to a record high of 11.2%. Unemployment in Spain is highest at 24.8% with 52.7% of youth unemployed. Perhaps the big surprise in Europe is the speed with which German indicators are weakening suggesting that it too is heading into recession. As in the US, European June quarter profit results have been coming in better than feared with 55% beatings on earnings and 62% beating on revenue.
• Japanese data was generally weaker than expected with softer than expected readings for industrial production, household spending and housing starts and a fall in the PMI business conditions indicator for July.
• In China, the official and HSBC business conditions PMIs suggest that growth has stabilised but that it is yet to improve. Chinese Premier Wen Jiabao again stressed that supporting growth was the priority but is yet to follow through with additional stimulus. Another monthly gain in house prices in July adds to confidence that the housing sector is not collapsing but also supports the view that the Government won’t relax its housing constraints. However, we continue to expect more rate cuts, reserve ratio reductions and fiscal stimulus in the months ahead with low inflation leaving plenty of room for extra stimulus.
• The slowdown across Asia is continuing with weak readings for exports and industrial production in Korea, a contraction in GDP in Taiwan and a fall in manufacturing conditions in India. While high inflation is constraining the Reserve Bank of India from cutting rates, more rate cuts are likely in Korea and Taiwan.

Australian economic releases and implications

• Australian data releases were mostly positive. The AIG’s manufacturing conditions PMI fell sharply in July and credit growth remained soft, but against this new home sales rose marginally, building approvals only reversed a fraction of their huge surge in May, house prices rose, retail sales rose strongly for the second month in a row and the trade balance returned to a small surplus in June. While the surge in retail sales in May and June is likely partly temporary reflecting the $2bn in Government handouts, the generally positive tone to recent data provides scope for the RBA to sit back and leave interest rates on hold for now.

Major market moves

• Shares had a messy week, falling on annoyance at the lack of immediate action by the ECB and Fed.
• It was a similar story for commodity prices, although strong Australian data releases along with ongoing talk of foreign central banks diversifying their forex reserves saw the $A hold up pretty well.
• Bonds yields fell in the US, Germany, UK and Australia but backed up again in Italy and Spain.

What to watch over the week ahead?

• In China, July activity data (due Thursday) is expected to show a stabilisation in growth around recent levels with industrial production up 10.4% year on year and retail sales up 13.5%. Inflation is likely to have fallen further to 1.8% leaving plenty of room for more monetary easing.
• In Europe all eyes will be on whether Spain and Italy apply for EFSF, and hence ECB, assistance.
• In the US the June quarter profit reports will start to wind down and data for trade will be released Thursday.
• In Australia, the Reserve Bank is expected to leave interest rates on hold. Even though inflation is at the bottom of the RBA’s target range, recent commentary from the RBA has indicated a relatively relaxed stance on the economic outlook and various economic data releases over the last month including for retail sales and house prices have indicated a somewhat stronger tone. Ultimately, we see the RBA resuming rate cuts again around October as growth indicators return to a softer tone and inflation remains benign, but for now we expect the RBA to remain in wait and see mode. The RBA’s Statement on Monetary Policy (Friday) will be looked at closely for clues as to how long the wait and see mode might last. On the data front, expect a 0.5% gain in housing finance (Wednesday) & a 10,000 loss in July employment (Thursday) pushing unemployment to 5.3%.
• A handful of Australian companies will start to report June half profit results including Leighton, Computershare, Cochlear, Rio, Tabcorp and Telstra. Results are expected to be weak on the back of falling commodity prices, the strong $A, cost pressures and poor domestic demand. The risks are likely on the downside to consensus expectations for a 1% fall in earnings for 2011-12. Resources stocks are likely to fare the worst with a 15% fall in profits under the weight of falling commodity prices at a time of cost pressures associated with massive investment programs. Financials and industrials will likely be constrained but have modest positive profit growth of around 3 to 4%. Key things to watch are dividends given the focus on yield at present and outlook statements with consensus expectations for 9% profit growth in 2012-13 likely to remain at risk. Hopefully falling interest rates may have provided a bit of scope for hope for domestic cyclical stocks.

Outlook for markets

• The short term inaction by the ECB and the Fed has left shares vulnerable to the deteriorating economic outlook in Europe, the US slowdown, lingering worries about China and the upcoming profit reporting season in the case of Australian shares. However, if the ECB and Fed follow up with policy action, as they have foreshadowed, shares will benefit as valuations are attractive and investors are very bearish which is a good sign from a contrarian perspective. We remain of the view that shares will be higher by year end.
• While sovereign bonds in safe countries are a good diversifier, bond yields in major countries around record lows suggest very low medium term bond returns. Corporate debt is a better proposition for those after income but not willing to accept the volatility that comes with shares.
• The Australian dollar is likely to remain strong by year end as global central banks undertake further monetary easing, commodity prices hold up and as central bank reserve diversification continues.

6 August 2012

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The Reserve Bank leaves the door open for further cuts. “At today’s meeting, the Board judged that, with inflation expected to be consistent with the target and growth close to trend, but with a more subdued international outlook than was the case a few months ago, the stance of monetary policy remained appropriate.”

What does it all mean?
The Reserve Bank is back in wait and see mode. After providing the economy with substantial rate cuts over the past couple of months the Reserve Bank has once again stepped to the sidelines. The statement following the “no change” decision was decidedly cautious highlighting the potential adverse risks surrounding Europe. Given the added level of insurance taken out in the last few months the Reserve Bank can afford to sit back and get a better gauge of what effect the rate cuts have had in spurring activity.

Importantly from an economic sense interest rates are below long-term averages, inflation is at the lower end of the target band, monetary policy is at a stimulatory setting and economic growth is picking up pace albeit from below trend levels – allowing the Reserve Bank time to get a more accurate picture of the economic landscape.

The anecdotal evidence suggests that activity levels have shown signs of improvement in recent months. House prices have started to rise, businesses are more willing to borrow given the attractive rates on offer and it is likely that retail sales will benefit from the Federal government handouts over coming months. Granted there are still an array of sectors that are finding conditions difficult, however the tough trading conditions is more as a result of a lack of confidence than any significant structural issue.

Given the considerable degree of stimulus that has been thrown into the mix, the focus will shift to the challenges that the Australian economy is likely to face. And front and centre is the underlying strength in employment and the structural shift that is taking place across the economy given the mining boom and accompanying higher exchange rate.

In addition the dramatic shift in European policy over the past week would provide the Reserve Bank with a degree of encouragement, but it is the next few weeks which will be more telling in providing a better understanding the stability across the euro zone.

From the Reserve Banks perspective China is likely to also be a watching brief. If activity levels slow dramatically and commodity prices weaken further the Reserve Bank will be less hesitant to cut interest rates.

If rates are likely to move anywhere in coming months, the risk is clearly on the downside. Manufacturing, services and construction sectors are still finding conditions difficult while inflation is well contained. We have pencilled in a rate cut in August – after the next batch of inflation figures in late July.

Interest rate decision and past cycles

• The Reserve Bank Board kept the cash rate steady at 3.50 per cent. The previous rate cuts were in June (25 basis points), May (50 basis points) and November and December 2011 (each by 25 basis points).
• Prior to those moves the Reserve Bank had previously lifted rates seven times from October 2009 to November 2010 – a total of 1.75 percentage points, from 3.00 per cent to 4.75 per cent.
• In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. In the previous rate-cutting cycle the cash rate fell to 4.25 per cent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
• The Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the variable housing rates of major banks are around 7.05 per cent, slightly below the long-term average or “normal” rate of 7.20 per cent.
• The RBA says that “interest rates for borrowers have declined to be a little below their medium-term averages.” In other words stimulus is still very modest.

What are the implications of today’s decision?
It is clear that the Reserve Bank is waiting on the inflation data which is released at the end of July. A low inflation reading would allow policymakers to feel more comfortable about cutting rates in coming months, if they deem it is necessary.

Retailers have reason to be hopeful. Consumer spending power has been boosted in the past few months. Not only have interest rates fallen but also cheaper petrol prices are supporting household balance sheets. The key will be confidence.

The rate cuts will provide a modest degree of stimulus however given the downside risk to global growth it likely that policymakers will maintain an easing bias. CommSec expects rates to be cut once more within the next three months.

4 July 2012

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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.

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“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.

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