21
Dec
2011

>Commonwealth public servant numbers – up 6.0% in 3 years

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The Australian Bureau of Statistics has just released an update on the number of public servants. http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/6248.0.55.002Main+Features12010-11?OpenDocument

According to the ABS, between June 2008 and June 2011, the number of Commonwealth public servants rose by 6.0% – from 237,100 to 251,400, a rise of 14,300. In Canberra, there were 80,400 public servants employed by the Commonwealth at end June 2011.

For the overall labour force data (taken from a different survey by the ABS), total employment over the same three-year time frame rose by 5.2% or 561,000. The slightly faster pace of employment growth in the Commonwealth public service could be linked to the start date – June 2008 – the middle of the GFC – which no doubt hit private sector employment more than the public sector. Either way, the difference between 2.0% average annual growth in public sector and 1.7% in the whole economy over that three-year timeframe is small beer.

While acknowledging the different surveys for employment numbers, it is reasonable to assess that the rise in Commonwealth public servants accounted for just 2.5% of the overall rise in employment; State and Local government employment accounted for a further 23.2% of jobs created over that time; meaning that the private sector accounted for around 74% of all jobs created over that time.

Not sure what it means exactly, other than at face value, the size of the Commonwealth public service is not growing at a materially different pace to employment in the rest of the economy.

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20
Dec
2011

>Peter Costello Speaks With Forked Tongue

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Correction: The text below has been corrected to show that the peak tax to GDP ratio in 2004-05 and again in 2005-06 under the Howard government was 24.2%, not 24.1% as originally published. The text below is now correct. SK

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Today’s Op Ed in the SMH and The Age from former Treasurer and Deputy Liberal Leader, Peter Costello outlines some very valid issues concerning the importance of sound public sector finances and in particular, the problems poorly managed fiscal settings deliver. Costello rightly cites the woes of many economies in the euro zone as evidence of poor economic management.

But that’s about as useful as his piece gets.

Costello suggests, without specifying the date that:

  • Once upon a time we could have shared our experience at managing and eliminating public debt. We could have shared our experience on how to halt a ratings downgrade and restore a sovereign credit rating to triple-A.”

Why the so-called sharing of “our experience” is no longer valid is not specified by Costello. He implies it is due to the factually flawed assertion of “bigger government and bigger borrowing”.

There are also some inconvenient facts that undermine Costello’s commentary. Never once during the Howard government during which Costello was Treasurer for the whole time did Australia achieve the triple-A credit rating from all major credit rating agencies. With Fitch moving Australia to triple-A last month, Australia for the first time ever has the trifecta of triple-A from all three agencies. This is a truly magnificent endorsement of Australia’s economic position and management over many years so little wonder Treasurer Swan was Euromoney’s Treasurer of the Year.

Costello was never Treasurer of the Year and after the worthy tax reforms associated with the introduction of (the watered down) GST, he sat back while the asset price and mining booms saw his period as Treasurer reap the highest tax to GDP ratio ever recorded in Australia’s modern history at 24.2%. In 2010-11, this ratio was at multi-decade lows of 20.0%. Is this how he suggests the Europeans should fix their fiscal problems? Boost the tax to GDP ratio to record highs?

In terms of “bigger borrowing”, it was the Howard government via Costello that maintained a market for Commonwealth Government bonds after serious consideration was given to eliminating it. Fair enough too. This meant (rightly so) that Australia would always have public sector gross debt into the tens or hundreds of billions of dollars. Costello chose to maintain and build up gross debt – ie, government borrowing. The Gillard government has reiterated that objective for the bond market and after consultation with stakeholders, including the RBA and Treasury as well as major market participants, and also in reaction to the Basel III requirements for banking regulation, the Gillard government will maintain the bond market at around 12-14% of GDP into the distant future. In other words, the gross debt to GDP will, for ever more, be around 12 – 14% of GDP. This is sensible, prudent and savvy policy.

It is also worth looking at what Costello said in 1999, shortly after the Budget and in reaction to a ratings upgrade for Australia from Standard & Poors.

He quite rightly said:

  • · This is a recognition by an international ratings agency of the strength of the Government’s budget policy. As the ratings agency announced, it’s a consequence of good economic policy and it means that Australia is again being regarded internationally as a very strong economy”

He went on:

  • · It also means that Australian companies will find it easier to borrow at lower rates. It will be good for economic growth and that will be good for jobs in Australia…it’s a consequence of long, hard, good economic work by this Government and it shows the benefits that economic reform will have.”

Costello does not use such words now even though Australia’s sovereign rating is now better than back then and better than at any time in history, including the 11 and a half years he was Treasurer.

Finally, it is important to note that the Howard government never had an objective for the budget to be in surplus. On the contrary – in the 1996 Charter of Budget Honesty, the Howard government objective for the Budget was “to maintain budget balance, on average, over the course of the economic cycle.” No mention of surplus. The “balance on average” means that an occasional surplus would be met with an occasional deficit – which is exactly how fiscal policy should be run when there is a business cycle to contend with.

Costello’s hollow words do not stack up against his record as Treasurer or the management of the business cycle during and after the GFC.

The Peter Costello article is here:

http://www.smh.com.au/opinion/politics/does-china-hold-the-answer-to-europes-sovereign-debt-woes-20111220-1p3vt.html#ixzz1h6xnJtwB

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20
Dec
2011

>A betting plunge on a 50bp rate cut in February

>The betting odds for a 25bp interest rate cut from the RBA in February has come into $1.40 with Centrebet, with a 50bp cut also heavy supported into $4.50. No change is out to $3.25.

A few days ago, the odds were $2.20 for no change, $1.70 for a 25 cut and $7.50 for a 50 cut.
The huge shortening in odds is despite the RBA minutes today which some misinterpreted to suggest the interest rate cut in December was a close call. It wasn’t. There is also the curious assessment from the RBA and those who never question the RBA judgement that the economy is growing at a trend pace – it isn’t. That’s false.
Just to reiterate – the economy is now growing at a below trend pace, a point proven by the softness in employment and the deceleration in inflation.
A quick economics lesson – when an economy is recording a trend rate of economic growth, unemployment and inflation are broadly steady. That is by definition.
This is not the case now. The unemployment rate his risen from 4.9% in early 2011 to 5.3% in November. Underlying inflation has fallen from 5.0% to under 2.5%. GDP growth has averaged a rather pedestrian 2.0% for the last 3 and a half years. Basic facts supporting the assessment of below trend growth.
As discussed here yesterday, http://tiny.cc/khi2o, the market is correct to seriously consider a 50 bp cut in February. Today’s RBA minutes do nothing to change that assessment and the betting market moves agree.
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20
Dec
2011

>RBA Minutes – What’s Happened Since

>The minutes of the 6 December RBA Board meeting were written in a way to suggest the decision to cut was not a forgone conclusion. I suspect the truth lies with the decision being a done deal as global conditions and local data remained subdued.

How ever the minutes were crafted, the information available since that meeting confirm further problematic data which will no doubt force the RBA to cut again in February.
7 Dec: GDP +1.0% – much as anticipated by the RBA.
RBA Minutes noted: The national accounts for the September quarter would be released the day after the meeting. Growth in private demand was expected to be strong, led by business investment. Growth in output, however, was expected to be less than that of demand because of the high import intensity of much of the current investment and the appreciation of the exchange rate.


8 Dec: Labour Force – jobs fell 6,700, unemployment rate up to 5.3%, participation rate down to 65.5% – probably weaker than anticipated given jobs fell.
RBA Minutes noted:
Employment was estimated to have risen by 10,000 in October and the unemployment rate had declined slightly to 5.2 per cent, which was ¼ percentage point higher than earlier in the year. The various forward-looking indicators continued to point to moderate employment growth.
12 Dec: International Trade – surplus $1,595m; exports down for 2 straight months – no surprise.
12 Dec: Housing Finance – rose 0.7%; still soft.
RBA Minutes noted:
Housing credit was increasing at an annualised rate of 5–6 per cent, as it had for much of the past year.
13 Dec: Business conditions +1 point; business confidence -2 points. Little changed from previous month, but still soft.
RBA Minutes noted:
Measures of business confidence had, however, generally picked up a little over the past couple of months, after earlier large falls. Measures of current conditions were around average, although large differences continued to be evident across industries.
15 Dec: Consumer sentiment: fell 8.3% to be at a level consistent with a retail sector recession.
RBA Minutes noted:
Surveys suggested that consumer sentiment had also picked up and was now back to a little above its long-run average level.
Global conditions have not provided any encouragement from the RBA’s assessment that:
It seemed highly likely that the sovereign credit and banking problems would weigh heavily on economic activity there over the period ahead, and there was a non-trivial possibility of a very sharp contraction. Global financial markets had experienced considerable turbulence, and financing conditions for banks had become much more difficult, especially in Europe. Overall, members concluded that growth in the world economy was likely to weaken over the coming year.


There is still so much that will happen over the next 7 weeks until the February RBA meeting. Critical local indicators will be the labour force and CPI releases in January. Soft results here will not only lock in a 25 basis point cut, but open the door for a cut of 50 basis points. Global issues, as always, will help guide the RBA thinking with all eyes on China, commodity prices, financial conditions and G7 growth.
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19
Dec
2011

>Bond yields keep falling

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Yesterday’s article on the record low Government bond yields in Australia (here http://tiny.cc/vp6jt ) was given a bit of a boost overnight and this morning with yields hitting fresh record lows.

Early this morning, the 3 year yield is at an eye-watering 2.98%, while the 10 year yield is tracking at 3.69%. These are figures never before seen. The interesting issue is how much more will they fall?

My guess is that poor market positioning (investors caught on the hop by the RBA interest rate cuts, the collapse in inflation etc), further downside inflation pressures and Australia’s rolled-gold AAA sovereign credit rating will spur yet lower bond yields in the months ahead.

How low is always difficult (impossible) to get a grip on but if inflation tracks towards 1.5%, the RBA cuts official rates towards 3.0% and global conditions continue to fracture, 10 year yields could drop a further 30+ basis points. Maybe more.

It should be noted that Australian 10 year yields are still around 190 basis points above those in the US and frankly, given the relative economic fundamentals, would investors prefer to lend money to the US government for 10 years for a nominal return of 1.8% or to the Australian government for a return of 3.7%?

I think I know what I’d prefer.

Another issue standing out with these market moves is the official cash rate. While the RBA has surprised almost the entire bunch of market economists by cutting rates in November and December, the 4.25% cash rate is 125 basis points above the 3 year yield and some 55 points above the 10 year yield.

Which is another reason why the RBA will seriously consider a 50 basis point rate cut when it next meets in February. The current 4.25% cash rate is inconsistent with the information in bond pricing. The inverted yield curve beyond the cash rate is screaming “recession” and while a recession in Australia is a very, very low probability, that assumes the RBA does its bit and cuts rates quite aggressively through 2012.

I was thinking that a 3.5% trough would be the low point for the cash rate in this current interest rate easing cycle. But the more the Chinese economy slows, commodity prices fall, inflation dives, local house prices drop and the labour market softens, the more open I am to all of the risks to this projection being to the downside – ie, the RBA may well have to go to 3.0%.

The market is pricing in a 2.75% cash rate for the second half of 2012. It might just be right – again!

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19
Dec
2011

>Could the RBA cut 50 basis points in February?

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At the moment, there aren’t too many people thinking the RBA will cut 25 basis points (bp) in February, let alone 50. But increasingly, the clever money is starting to seriously price in the possibility of a 50bp cut. The IB market is now close to fully pricing in a 50bp cut (about an 85-90% chance).

What would make the RBA go 50 instead of 25?

Critical will be the December quarter CPI due for release on 25 January. As a negative headline result looks likely for inflation (the prices of many goods are falling), the underlying measures are also set to remain near the 14 year low result of 0.3% recorded in the previous quarter. A low result, plus the current mix of other influences means the RBA will go at least 25bps, but a surprisingly low inflation result will open the door for a 50 cut.

From an Australian perspective, what happens in China will dominate issues in Europe and the US, although admittedly, these are all inter-related. Signs in China of weakening property prices, dodgy banking issues, falling share prices, falling inflation and weakening GDP are massive risks for the Australian economy. If the trends in these and other measures in China intensify, the RBA may wish to go hard. Broad commodity price measures are already weak and any further softness will present a significant downside risk to Australia.

The banks funding issues will also be important for the RBA. While finance is clearly available, it’s the price of getting money that is causing a margin squeeze for our friends in the banking sector. If wholesale funding costs remain high or get even higher, the RBA may want to go 50 knowing that there will be 30 or 35 bps for retail interest rates and 15 or 20bps for the banks. This alone would be a good reason to go 50.

We can then throw in the usual run of other data between now and the February meeting – most notably the December labour force data which if weak again would demand an aggressive RBA approach. Retailing looks to be in recession, as is government demand under the weight of aggressive fiscal contraction.

I might be talking myself into it, but I am getting close to thinking the RBA will cut 50 in February. Like all mere mortals, including those at the RBA, the drip of news over the next 7 weeks will help determine what it does.

Maybe the risk is they go more than 50 if market conditions fracture. That’s for closer to the time of the February meeting.

I note that for the February RBA meeting, the TAB is offering $7.00 for the RBA cutting by 50 basis points or more. This looks to me to be great value given the risks out there right now. Off to the TAB I go.

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18
Dec
2011

>Australian Bond Yields Hit Record Lows

>The yield on a 10 year Australian government bond is trading at a record low around 3.73% this morning. There are several factors which go determine bond yields, but the most notable are inflation and risk.

Inflation matters because an investor would be unlikely to want to lend money to the government for 10 years (that is, buy a 10 year bond), if the return (annual interest rate) is eaten away by inflation. The higher the expected rate of inflation, the higher the yield needed to attract investors to buy and hold that bond.
The current record low yield on Australian bonds suggests investors are expecting inflation to be very low over an extended period of time. The near 20 year lows for board commodity pricesplus the massive amount of spare capacity in the global economy suggests this to be a well founded backdrop to the current record low yields.
A dominant issue at play now and in fact in recent years is the pricing of risk into bond yields. Again, think of an investor buying a 10 year bond. The greater the risk of default by the government, the higher the premium (interest rate) required by an investor to make that trade. With Greece clearly a high risk of default, it is no surprise that some of its bond yields hit 100%. What return would you insist on if you thought it likely the entity wouldn’t pay you back? With risk of an Italian default rising, it is also no surprise its yields have skyrocketed.
With the risk of a US or German default on bonds very low (it seems), yields in those countries are around 1.85% – also near record lows. They are big enough to keep printing money to pay back investors – or at least that is the common perception at the moment.
For Australia, which is one of only 8 countries (at last count) that has AAA and stable ratings from all three major credit ratings agencies, sovereign risk is assessed to be one of the lowest in the world. The risk of the Australian government defaulting on a bond is as close to zero as you can get – hence the record low yields.
On balance, it seems likely that Australian bond yields can fall further. Some in the market are still spooked by inflation for some unknown reason and there is some hopelessly ill-informed chatter about sovereign risk in Australia. When these misunderstanding fade further into the back blocks with updated data on falling inflation and the return to Budget surplus in 2012-13, we should see yields continuing to meet new record lows.
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18
Dec
2011

>Sloan gets it wrong

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Judith Sloan reckons that “the prospect of an actual budget surplus … looks reasonably remote.”

She cherry-picks a range of data and gets some facts wrong to conclude that a couple of years ago we saw “the biggest splurge in government spending since Gough Whitlam was in office.”

The Sloan article is here.

http://www.theaustralian.com.au/national-affairs/opinion/reckless-spending-reigns-as-storm-clouds-gather/story-e6frgd0x-1226224285553

It’s a strange article. There was no reference at all to the Global Financial Crisis and the fact that Australia was one of few countries to avoid recession. She fails to acknowledge or reference what is a common assessment that the fiscal response was a key factor behind that world best performance.

Sloan also looks at the issue of the budget from one dimension noting that if the economy is weaker than projected, there will be a deficit in 2012-13 (which is true), failing to note that if the economy happens to be stronger, the surplus will be larger (which is also true)! Pretty basic stuff.

In terms of some specifics, Sloan makes a hash of her analysis of fiscal settings.

Sloan notes that: “General government expenditure went from 23.8 per cent of GDP to 25.9 per cent in one year (2007-08 to 2008-09). It rose further in 2009-10, to 26.3 per cent.”

Those numbers are wrong: According to Table D1 in the recent MYEFO, general government expenditure rose from 23.1% of GDP in 2007-08 to 25.2% in 2008-09 and reached 26.0% in 2009-10.

Presumably because the facts don’t support her argument, Sloan did not mention the fact that expenditure fell 1.3% of GDP, back to 24.7% in 2010-11 and is projected to fall to 23.6% in 2012-13. Recall that the average level of government spending to GDP under the twelve Howard government budgets was 24.2%.

On these facts, I am not sure who is guilty of “reckless spending”.

Sloan then pulls out an old favourite by suggesting that “This short period saw the biggest splurge in government spending since Gough Whitlam was in office.”

The irony in that comment is that in Whitlam’s final budget, government spending to GDP was 24.3% (recall the average for the Howard government was 24.2%) a figure that blew out to 26.7% in the last Fraser / Howard government budget.

Sloan reckons “that scarce government funds have been spent on low-value programs, to prevent an economic downturn that Australia would probably have avoided by dint of aggressive monetary policy, the depreciation of the dollar and our links with booming Asia.”

Sloan might have been looking in the wrong direction when there was the threat of “an economic downturn” when the RBA cut interest rates to an all time low of 3%, the AUD fell to US$0.60 and the strong growth in Asia helped to support growth. How much more could have been delivered on any of these fronts is problematic. Every reasonable person knows the fiscal stimulus preserved thousands of jobs and with these other factors, helped Australia avoid recession.

It’s a weak article seemingly based on bias, prejudice and aimed to spin a line about some wasteful government spending. For Sloan’s sake, it’s a pity the facts suggest otherwise.

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14
Dec
2011

>Bank funding – it’s price, not access to markets that is the issue

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It is interesting to see a trickle of deals for some of the banks come through again as they try to lock in some term funding in the wholesale market. There is no doubt Australian banks have ready access to almost unlimited capital despite recent credit rating down grades. There are literally hundreds if not thousands of investors willing to buy Australian bank paper given Australian banks are some of the most credit worthy in the world and the sovereign background to them is even better.

Access to global capital markets for Australian banks is not the issue – nor has it been other than in the depth of the crisis at various times in 2008 and 2009.

The issue is price.

Like any offer to buy and sell (in this case bank debt), the price is the factor that determines whether a deal gets done.

The banks “difficulty” of gaining access to wholesale funding results from the fact that investors are demanding a higher return to lend more money to the banks – but the banks are less than enthusiastic when it comes to paying that higher price. Both of these factors create a temporary impasse in that market and leave an impression that the banks cannot get access to wholesale funding. That was and still is wrong.

Eventually something has to give and in this case, the banks as price takers have to pay more for their funding. This is the crux of the issue of bank funding right now.

It is not and frankly never was access to capital that is causing banks their concern – to reiterate, it is the cost of that funding. From the wholesale market, the price of that capital continues to rise. Risk has increased as housing (and with it banking) in Australia is less robust than a year or so ago. This is the issue that will mean that official interest rates will have an increasingly unpredictable impact on retail interest rates.

The cost of running a bank is increasing – it’s as simple as that.

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14
Dec
2011

>Parkinson and Battelino Singing the Same Tune

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In the last 24 hours, Treasury Secretary Martin Parkinson and the outgoing RBA Deputy Governor Ric Battelino have given important speeches on the economy and issues that will likely dominate the policy focus into 2012.

For Parkinson, there was the usual frank assessment of the issues confronting the economy into 2012. While the main risk noted by Parkinson was intertwined with the problems in Europe, he went out of his way to highlight the ongoing moderation in government revenue from what will become a protracted period of mediocre growth in the economy.

Most disconcerting, but a point that is increasingly apparent to those willing to look outside the local economy for clues to the outlook and risks for Australia, Parkinson noted that “Chinese inflation’s peaked. The [Chinese] economy’s slowing … it would be appropriate to start to ease off on monetary policy and that’s essentially what’s happened in China.”

This is big.

For uber hawk Battelino, who rarely sees any downside risks to growth or inflation in Australia, there are some negative aspects to the Australian economy. In particular, Battelino made a clear statement that he and the RBA were concerned that events in Europe would impact on Australia, although the magnitude of the negative shock was hard to quantify.

He noted, “The large size of the euro-area economy and the significant role played by European banks in global cross-border banking mean that it is inevitable that there will be spillovers to other parts of the economy, including Australia.”

As 2011 draws to a close, it is refreshing to see the official family looking outside local events to see the issues that are likely to impact on the economy into 2012. It is adding up to a position where the Australian economy, although doing OK, is on edge with some negative shocks more likely than not to hit Australia in 2012.

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