14
Dec
2011

Parkinson and Battelino Singing the Same Tune

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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13
Dec
2011

The Soft Economy – Australia

It is strange that for a given set of economic statistics, there are so many interpretations of how well the economy is performing. For Australia, some interpret the recent run of data to suggest the economy is strong, some say weak, some say mixed. Many of those who judge the economy to be strong have the unpleasant characteristic of heaping scorn on those who think the economy is a little soft as they resort to derogatory comments.

An unkind person might say those boneheads would be wise to look at some hard data, in context, when assessing the current economic momentum and the outlook.

The difference in interpretation is hard to fathom, particularly when the broad range of economic data are considered and facts are not cherry-picked to suit an argument, which is so often the approach of the loudest proponents of the strong economy.

Right now, it is clear that the economy is a little soggy, growing at a pace below trend. No one can deny that, can they?

Can I present some facts – not my interpretation, just facts. Look at these and make up your own mind.

  • · GDP rose 2.5% through the year to the September quarter. Treasury estimate the long run growth potential of the economy to be a little above 3%.
  • · GDP growth in through the year terms has not exceeded 3.0% at any stage over the last 3 ½ years and has averaged a tepid 2.0% over that long timeframe. Capacity constraints have reversed and there is now a not insignificant output gap.
  • · In the 8 months since March, total employment has risen by a total of just 2,000; a tiny 300 per month. The participation rate has dropped 0.4% and the unemployment rate has risen 0.4% to 5.3%.
  • · nnIn the last three years, the underlying inflation rate has fallen from 5.0% to under 2.5%. The 0.3% rise in underlying inflation in the September quarter was the lowest quarterly result in 14 years.
  • · Housing credit growth is expanding at around 5.75% – the weakest growth rate in 34 years.
  • · Business investment rose by over 20% in the year to the September quarter, and is up more than 300% in the last 5 years ago.
  • · There is a mining investment pipeline of around $450 billion that is yet to be committed. In today’s dollars, this is around 35% of GDP.
  • · House prices have fallen for 8 straight months.

I don’t know how others interpret data; but 3 years of below trend GDP, no job creation for 8 months, rising unemployment and falling inflation are not the indicators of a strong economy.

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13
Dec
2011

>RBA Cut – Reduce the Number of Board Meetings

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The number of RBA Board meetings should be cut from the current 11 per year to a maximum of eight.

As exciting, interesting and enlightening each of the RBA Board meetings are for those of us watching and anticipating monetary policy changes, the current timetable for RBA meetings means that there is an almost unbroken, high profile, often erroneous running commentary on interest rates. No other country seems to have such an interest rate and monetary policy obsession. It’s almost unhealthy how much attention is placed on the RBA interest rate decisions each month when most of those decisions are to keep rates steady. When rates are adjusted from time to time, the moves are usually well anticipated by the market.

My proposed eight RBA Board meetings each year could be slated in for the Wednesday following the release of each quarterly consumer price index and each quarterly national accounts. This would spread the meetings and decisions on interest rates smoothly throughout the year. While no single CPI or national accounts release will drive medium term monetary policy settings, the growth and inflation results are important factors when working out how the economy is going which means the news from these releases will feed into RBA deliberations.

The 27% cut in the number of RBA Board meetings each year would have few procedural consequences. The release of RBA Board meeting minutes would be unchanged, other than to meet the requirement from there being fewer meetings each year. The Quarterly Statement on Monetary Policy could be maintained on something very close to the current timetable and the biannual appearance of senior RBA officials before the House of Representatives Economics Committee would also be unaffected.

There would also be a savings for the RBA. Apart from cuts to travel costs for Board members, RBA staff would have to prepare fewer Board papers freeing up resources for other research projects. There may even be a headcount saving for the RBA.

For financial markets, the various market instruments that price in anticipated changes in the official cash rate would be unaffected. The new dates for RBA meetings would be plugged into the spreadsheets and market pricing would be adjusted accordingly.

The new scheduling would help the RBA deal with the Melbourne Cup day problem where the monetary policy decision on that day each year competes with the race that stops the nation. Best to avoid that clash.

Of course the RBA would maintain its ability to meet and adjust rates in emergency or adverse circumstances, outside the timetable of regular meetings so nothing would change on this score.

The bottom line of the change would mean interest rate announcements would occur every six and a half weeks rather than the current four and a half week timeframe. The intense and seemingly unbroken commentary on “will they; wont they” hike or cut would be diluted at least a little bit. The other benefit would be that in setting retail interest rates, there would be a greater opportunity for banks to adjust rates according to changes in funding costs as those pressures emerge rather than being held to account each time the RBA changed rates.

It makes sense.

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8
Dec
2011

>RBA’s Glenn Stevens on Bank Margins & Other Matters

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Below are some fascinating comments from RBA Governor Glenn Stevens in 2010. Worth a quick read. Even more relevant today it seems.


“Since the middle of 2007 there clearly has been an increase in their overall costs of funds relative to the cash rate. That has been reflected in the widening of the margins. It has also been reflected in the cash rate being roughly, I would say, about 100 points lower than it would have been, to take account of that margin change and roughly—not exactly in any given month but roughly speaking—offset it so that the loan rates in place in the economy are, roughly speaking, about where we think they ought to be for the macroeconomic management needs that we have. We cannot finetune this on a month-to-month basis; we could not claim to do that. But over time, in the broad sweep, the big amounts, roughly speaking, have been offset by different behaviour by us on the cash rate compared to what we would have done otherwise.” My emphasis.

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“Business models that took particular advantage of low-cost wholesale funding or securitisation were able to provide a very competitive edge to certain markets, particularly—though not only— markets for mortgage lending. But investors changed their behaviour in 2007-08. The compensation that they require for taking risk now is higher. Therefore, wholesale funding and securitisation are more expensive. In the case of securitisation, in addition costs have risen in part because certain investors completely exited that market and are very unlikely to return. So there has been an increase in the cost which has affected all financial institutions but to varying degrees. Therefore, because the degree varies, it has also affected the competitive landscape. Some business models that did well in the earlier state of the world of course find it hard now. Part of the competitive advantage that they had for a time has been eroded by changes in market conditions. The current relationship between variable mortgage rates in particular and market funding costs is making it harder than it used to be for those lenders that rely on securitisation or wholesale funding to compete with the major institutions that have a more diversified funding base.

The changed attitude to risk also affects the locus of competitive forces. Four years ago the competition was all in lending money. There was very intense competition to lend. But now there is very intense competition to raise money on the part of financial institutions. Other things have happened as well that affect the competitive landscape, but this is a very fundamental change in the state of the world. ”

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8
Dec
2011

>A change in rhetoric required

>The banks have done a bad job articulating why changes in official interest rates are a moderate and declining driver of their lending and deposit rates. It has opened then to criticism and derision which is not a good thing. Much of that criticism has come from Treasurer Wayne Swan and his shadow, Joe Hockey who would be well advised to change their rhetoric when it comes to future moves in official rates and changes in retail interest rates.

While it varies from bank to bank, the official cash rate would closely influence not much more than half of their funding. Banks get about 50% their funding from deposits, 40% from debt raising in capital markets both on and offshore and 10% from other odds and sods.
In recent times, term deposit interest rates have gone from being below the cash rate to well above it. That obviously increases funding costs or in other words, the cost of doing business. In the wholesale market, both on and offshore, global credit issues means banks have to pay a lot more – relative to the cash rate – for that funding as global investors judge such investments as increasingly risky. If we want our banks to remain profitable, it is only natural that the higher cost of opening the doors each morning at your local bank branch is passed through to customers.
While the banana milkshake analogy may have been poorly articulated a few years ago, no one seems to have the same outrage when the local barista hikes the price of coffee by 50c when a frost in Brazil raises the cost of inputs. Nor has there been the same yodelling when a hamburger price rises $1 because beef (and the off cuts) prices rise. And no one (that I am aware of) has praised the banks in recent years for offering deposit rates 150 basis points or more above the cash rate, reversing the practise of paying lower interest rates.
They also forget that the RBA is more or less targeting the mortgage rate and if for whatever reason those mortgage rates move higher against the RBA’s preferred option, it would cut official rates. If mortgage rates fell due to lower funding costs, for example, the RBA would hold off cutting the official rate, knowing the banks were doing some of the work for them.
The tail is wagging the dog.
Mr Swan would be wise to stop bank bashing. He will not win any more arguments when the banks almost inevitably fail to match any future moves in the RBA cash rate. Credit conditions don’t look like they will be easier any time soon. And Mr Swan should also remember that the banks holding margins to maintain profitability is free – it costs nothing to the budget and lessens the need for government guarantees for the banks. One only has to look at current debacle in the UK, US and much of Europe to see the consequences of government funded bank bailouts. It is depression like in its consequences. We do not want Australia to go anywhere near that.
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8
Dec
2011

>ANZ Retail Rates – A New Calendar Event!

>The decision of the ANZ to announce retail interest rates each month (on the second Friday) delivers a new market watching event. It’s like a new data release – a new RBA guide – it’s a bank funding signpost. For data and market wonks, it’s great!

There is a strong likelihood that the ANZ could tweak rates up or down 5 or 10 basis points each month regardless of what the RBA does, but rather according to trends in funding costs and demand for credit. And this is entirely reasonable. Financial markets ructions and the broader funding sources for banks means that the cash rate – for now at least – is less relevant to the interest rates you and I pay on our loans or receive for our deposits. Right now, you can get 6.0% of a 6 month term deposit – a whopping 175 basis points above the cash rate. Great stuff for savers and perhaps more importantly a sign of just how tough or rather how expensive alternative sources of funding are for the banks.
I am pretty sure the banks wouldn’t be paying those sorts of interest rates on deposits if other funding sources were either cheaper or available at the official cash rate. To highlight this shift of focus, one only has to look back at term deposit rates versus the cash rate prior to the GFC (when money was freely lent to any Tom, Dick or Harry – few or no questions asked). Back then, there were almost no examples of banks offering terms deposits above the cash rate and in fact the margin below cash was often triple digit basis points.
The end point of this is that the game is changing. It’s too early to be sure how it will evolve – but the increasing focus of the RBA when it sets the cash rate will be where retail lending rates are. If funding pressures force lending rates up and the RBA sees this as unwelcome with reference to its inflation target, it will cut the official rate more than otherwise to try to bring retail rates lower – and vice versa. It will be fascinating to see how the new order pans out.
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8
Dec
2011

>Employment falters – again

>The patchy nature of growth around Australia continues to show up in the labour force data. In the 8 months since March 2011, the unemployment rate has gone from 4.9% to 5.3%; full-time jobs have fallen around 75,000, part-time employment has risen by around 77,000 and total employment is up a wafer thin 2,000 (rounded). That’s average monthly employment gains of a puny 300 – that’s a tad disconcerting.

These jobs data fit with news elsewhere of slowing job ads and the deceleration in wages growth in recent times. While the labour market lags the economic growth cycle, it seems likely that the unemployment rate will edge up towards 5.75% by the middle of 2012 as the economy maintains a below trend growth rate. This will further free up capacity which will further dampen wages and with that inflation.
At this stage, there is not too much fear in any expectations that the unemployment rate will ratchet up beyond 6%. After, the RBA has correctly and pre-emptively started an interest rate cutting cycle and the moderation in wages growth will act to support labour demand. The assumption of a peaking unemployment rate below 6% is that monetary policy will turn accommodative in the first half of 2012 and that as a result, growth will edge up by end 2012 and in 2013, labour demand will also turn higher.
The result fits with the scenario of a few more rate cuts from the RBA into 2012 – for now, I will stick with the view that the RBA will be cutting to 3.5% by mid-2012. The recent run of data just go to show how well the RBA has been reading the economy and then putting into action policy changes without fear or favour.
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7
Dec
2011

>Bank margins and pass through

>The RBA adjusts official interest rates knowing that some banks may not pass it on. And pass it on to whom is a difficult question – mortgages, small business, big business, credit cards, deposits? No one seems to report the fact or give two hoots that all banks are offering 3 to 12 month terms deposits 100 to 150 basis points above the cash rate. That windfall margin to savers does not attract the rage of Wayne Swan or Joe Hockey.

In any event, the interest rate cut yesterday will have one of two issues attached to it: If it is passed on in full, the RBA gets maximum bang for its buck and borrowers with variable loans will see an improvement in their cash flow; they will be encouraged to spend and borrow more; supporting growth and so on. Great.
If the banks pocket some of it – for arguments sake, 10 basis points and pass on only 15 basis points – the RBA will have given a bit to borrowers and a bit to the banks. Both benefit. When funding issues are becoming more acute as they are now, it may not be a bad thing for the banks to hold on to some of the cut. Frankly, it matters little if banks do or don’t pass it on because it will be the behaviour of the economy which is determined by much much more than interest rates and bank margins that will determine future monetary policy moves. If banks don’t pass any on, and the economy is weak, then the RBA will cut some more. Obviously.
And finally, it is a completely free way of supporting the banks. It costs nothing to do. There are no extensions of government guarantees, no quantitative easing requirements which screw up your bond and currency markets, no need for the government to write a cheque as the odds of a bank failure shorten. It’s a free lunch.
The RBA cut hard during the GFC knowing banks needed support and most other major central banks are doing some form or other of the same policy right now. While key macro data will determine future changes in official interest rates, so too will the health of the banking sector, its access to money and the price it pays to get money to lend to you and me.
It’s very simple.
Bank competition and efficiency in that sector is a different question that I might cover another day. Maybe.
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7
Dec
2011

>GDP up 1.0% – A Nice Result

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The 1.0% rise in GDP in the September quarter was a solid result. It follows the flood rebound induced 1.4% rise in GDP in the June quarter and the flood dampening fall of 0.7% in March quarter GDP.

The numbers are still be messed around by that flood impact and the subsequent recovery. Suffice to say, if we look at the last three quarters, GDP growth has averaged around 0.6% per quarter or an annualized pace of 2.5% – coincidently (perhaps) this is the same as the through the year growth rate of 2.5%.

The economy is expanding at a reasonable clip – clearly not quite fast enough to stop the unemployment rising a bit (from 4.9% to 5.2% with an update tomorrow), and growth is clearly at a pace that is soft enough to help inflation pressures ease (underlying inflation has fallen from 3½% to below 2½%).

The numbers (unsurprisingly) fit pretty closely with the revised forecasts of Treasury and the RBA – with the two interest rate cuts likely to put some sort of floor under the 2.5% GDP growth momentum currently being recorded.

Whatever the factors influencing GDP growth in recent years, it is interesting that it has been over 3½ years (14 quarters) since through the year growth exceeded 3.0% – quite amazing really. The average rate of GDP growth over the last 3½ years has been just 2.0% – which is very weak compared to trend, but a factor that has clearly driven the easing in capacity constraints and the sharp drop in inflation.

The mix in the growth data are generally favourable: solid growth in personal consumption, falls in public demand (further unwinding of the stimulus) and big growth in business investment (mining). Net exports cut growth and it would be nice to see net exports adding to growth rather than subtracting, but the CAPEX boom is fuelling strong import volume growth and this is the price paid for the investment boom.

The end point is that there is not a lot of extra news for policy makers in the result. Let’s have a look at the jobs numbers tomorrow for a bit more information on the state of play in the labour market and then the long wait until the December quarter CPI on 25 January which should give the RBA the ammo it needs for another 25 basis point cut.

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6
Dec
2011

>Economists vs the Market

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A friend sent through to me a Reuters survey from 18 February this year with 24 market economists outlining their forecasts for the cash rate for December.

None thought that interest rates would be cut from the 4.75% level prevailing at the time and a couple thought that the RBA would hike the cash rate to 5.75%. The best forecast was from BNP Paribas (their European heritage influencing their thinking?) who thought the RBA would be on hold for the year. Everyone else had a hike or two or three or four by December.

The reason I point this out is not to bag out these forecasters for their rotten forecasts – it is a tough gig. I am not sure how I would have responded to this survey. But it shows yet again how hairy forecasts for even less than a year can be, and how unfolding events can change the game.

A similar survey of market economists from June wasn’t much better – no one saw cuts, even though the extent of the rate hiking cycle had been scaled back. This was about the time when the market, as it turns out correctly, starting pricing in aggressive interest rate cuts much to the scorn of many in the market (yes Adam).

It would be very interesting to see some self-reflection from those in the market about their forecasts at the start of the year. Treasury and the RBA do this when they update their forecasts. My guess is that market economists paid little or no attention to the massive fiscal policy tightening, even though it was obvious at the time.

Another mistake, I reckon, was that the market economists focused on China as an engine of growth and did not look at the whole global economy which was starting to fall in a heap early in 2011. Locally, I reckon too much attention was paid to the boom in mining and business investment and they ignored the free-fall in credit growth, falling house prices and stalling job creation as temporary or desirable trends. The floods in Queensland didn’t help with data interpretation but it was clear that growth was cooling in the early part of 2011 under the weight of tight monetary policy, tight fiscal policy and the booming Australian dollar.

Now it seems that almost everyone is calling for more interest rate cuts. Some of those forecasting 3 or 4 rate hikes earlier this year are now calling for 2 further cuts early in the new year. In framing these views, I hope they look more at government demand, focus more on credit growth, look at leading indicators for the labour market and the global economy as a whole and not just China. It is also to be hoped, as Ross Gittins pointed out yesterday, they look at issues objectively and not with a political bias that clouds their judgment.

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