24
Jan
2012

>The IMF and the RBA

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The RBA uses IMF forecasts for the global economy when building its assessment of the local economy.  It has done this for many years.  Obviously, the RBA judges the risks around these forecasts but nonetheless, when the IMF changes its outlook for the world economy, you can rest assured the RBA will use these in its assessment of Australian growth and inflation pressures.
In its November 2011 Statement on Monetary Policy, released after it delivered its first interest rate cut for this cycle on 2 November, the RBA published and used the then IMF forecasts for global growth.  The changed forecasts from the IMF released yesterday have seen it cut global GDP growth from this time by 0.1% in 2011, 0.7% in 2012 and a further 0.6% in 2013.  The IMF forecasts for Australia’s major trading partner, China, have been cut by a little more than average in both 2012 and 2013 (by 0.7 and 0.8% respectively).
Obviously the RBA knew there were downside risks to the prior IMF forecasts during the final months of 2011.  This is why it had no hesitation in cutting interest rates in November and then December.
But as the current drafts of the RBA Board papers for the 7 February meeting are being circulated within the engine room of the RBA, the material downgrade to the global growth outlook from the IMF would create concerns that local monetary policy needs to move to an accommodative setting.  Global growth is OK, but it is coming from a dismally weak base and it is also much less robust than thought even a few months ago.
Former RBA Governor Ian Macfarlane was once asked if he had just one indicator to look at when determining his forecasts for Australia and his judgments on monetary policy, he said it would be global growth.
I dare say if current Governor Glenn Stevens was asked this now, he would have the much the same answer.  This is why the IMF downgrade matters. 

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23
Jan
2012

>Good money chasing bad

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It’s so disappointing to see money being tossed away at inefficient car makers, uncompetitive steel manufacturers, risk taking farmers and to other areas of the economy.  It imposes a large cost which is usually spread across the whole economy for a very concentrated benefit to a few.

To be sure, the role of economic policy making in a decent society is to provide a safety net of basic support, retraining, reskilling and education for all those workers who happen to be in industries in decline – and we generally do that well.  But policy making is also about driving an agenda that is built around internationally competitive tax structures and increasing the ease at which the private sector can invest, expand and employ.

Allocating money to an industry that will never be able to compete with a higher quality, lower cost product made outside Australia is unsustainable.  Giving money to businesses that inevitable fail due to a flawed model (farmers who only stay on marginal land due to subsidies, drought relief and the like) is also horribly inefficient and costly.  Money allocated to first home buyers, while nice in theory, is a costly and demonstrably useless policy in terms of getting people into the owner-occupied hosting market.  Using that money, for example, to build infrastructure for new housing land and building low cost affordable housing would win any cost benefit analysis by the length of the straight.

Despite the stunningly favourable structure of the Australian economy right now, there remains some sacred cows of industry and business that governments, of both colours, have seen fit to nurture.  Thankfully some governments in the last 30 years or so have been tremendously courageous at reducing industry assistance.  I suspect if Australia is to be structurally sound in a decade or so, or whenever the mining boom reverses, we need to ramp up the reform agenda … and soon.

Did you know Australia used to manufacture televisions?  Preposterous!  Image if we still had those whacky tariffs in place that forced us to make and buy locally made TVs now?

Renaults, Mini Mokes and Austin Lancers (among many others) used to be made in Australia.  Huh?

Thankfully no more.

I hope that in 50 years, we look back and see how absurd it was that Australia had a car or steel industry at all.  I hope we have an economy based in high income, high skill jobs, not ones proped up by government distortions at a high cost to the economy.

The government needs to be err on the side of letting go, in the way it treats job losses in banking or small business or real estate or construction.  Let it happen.

Do nothing specific, but have in place a generous and well targeted retraining scheme, facilitate relocation to the strong parts of the country and leave in place an environment that allows for sustained solid economic growth that takes up the workers lost from the industries that will inevitably decline.

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23
Jan
2012

>Peter Costello Needs to Read the Budget Papers

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Former Treasurer and Board Member of the forever under-performing Future Fund, Peter Costello seems to be at it again.
Costello is reported on the afr.com web site saying:
  • Australia will end up in the same economic position as Europe if the government doesn’t start to curb spending, says former Liberal treasurer Peter Costello.   “Europe at the moment is suffering under a mountain of debt that it can’t service,” he told Macquarie Radio on Tuesday.  Australia’s longest-serving treasurer warned Labor to heed the lessons implicit in Europe’s demise, saying the government could only spend money it doesn’t have “for a while” before it will end up using all of its income to service its debt.
  • “This is what I have been warning about here in Australia for some time,” he said.
  • “If the journey keeps continuing at the rate in the years ahead that it did in the last three or four years it won’t be too long before we start experiencing European-type problems.

He seemingly hasn’t looked at any Budget or MYEFO papers in recent years because if he did, he would find the following, as I have reported here (http://tiny.cc/b4tak) and other places on this blog before:
  • Government spending to GDP averaged 24.2% of GDP during the 12 Budgets that Mr Costello delivered between 1996 and 2007. 
  • Government spending rose as a result of the stimulus measures during the GFC and peaked at 26.0% of GDP in 2009-10.  
  • It since fell to 24.7% of GDP in 2010-11.
  • Government spending to GDP is projected to be 23.6% of GDP in 2012-13.  
  • This will be around 1.5% of GDP below the average government spending to GDP ratio of the last 30 years and obviously below the average spending to GDP ratio in the Budget’s the Mr Costello delivered.

Whoops! 
And for the record, in only in 3 years out of 12 Budget delivered by Mr Costello was the government spending to GDP ratio lower than the Gillard Government is projecting for 2012-13.

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23
Jan
2012

>Producer Prices Are Well Contained

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The producer price index (PPI) rose 0.4% in the December quarter for an annual rise of 2.9%.  Over the last 3 years, the annual average increase in the PPI has been 1.3% with swings in the Australian dollar a major variable in driving shorter term results.
While there is only a loose correlation between changes in the PPI and the CPI, they tend to turn and exhibit extreme movements at more or less the same time.  Importantly, the RBA does often note the PPI when looking at broader inflation and monetary policy risks and today’s data suggest that upside inflation risks are hard to find.  If anything, inflation pressures seem to be easing from an already low base, a scenario that fits with the all but certain interest rate cut on 7 February.
All eyes will be on the CPI on Wednesday.  There remains a strong risk that the headline CPI will be negative and the underlying readings also very low.  If this comes to pass and the pressure on bank funding costs remains in the forefront on the RBA thinking, a 50 basis point cut is possible.

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22
Jan
2012

>What Wont Be Reported This Week

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I don’t think we’ll see this story anywhere after the inflation data are released this Wednesday – will we?  Could we?  Should we?  
————————————————————————-
WEDNESDAY 25 JANUARY 2012:
Today’s consumer price index confirmed that Australia’s inflation rate remained around its lowest level in a decade.  In underlying terms, the CPI rose by 2.3% in the year to the December quarter to remain in the lower part of the target range of the RBA.
The ongoing low inflation rate means that cost of living pressures remain comfortable for most Australians.  There have now been 10 straight years where average weekly earnings growth has outpaced the rate of inflation, boosting the purchasing power of all wage earners.  Further supporting the financial comfort of most Australians have been the unprecedented income tax cuts and increases in pension payments over the past decade.  Rises in electricity prices have been more than offset by falls in prices for clothing, electronic goods, computers, household appliances and fruit and vegetables.
The low inflation rate has money markets pricing in further interest rate cuts in the near term.  According to market pricing, the RBA is expected to cut the official cash rate by a further percentage point over the next 6 months with a 25 basis point cut priced into the market for next week’s meeting of the RBA Board.  This will be the third interest rate cut since November 2011 and will take the official cash rate to 4.0%.  Other market interest rates, such as the 10 year government bond yield, have recently fallen to all time lows.
In a damaging development for the Liberal Party’s economic credentials, a 4.0% interest rate would be a level of official rates never once reached under the combined 19 years of the Howard and Fraser governments, despite claims from the Leader of the Opposition, Mr Abbott and Shadow Treasurer, Mr Hockey, that interest rates will always be lower under a Coalition government. 

The stunningly low inflation result is a further embarrassment for the Liberal Party, which had policy settings in place in 2006 and 2007 that spurred underlying inflation to a 15 year high of 5.0%.  Market economists agree that inflation is currently well under control and is forecast to remain within the RBA’s target range for at least another year, which will help lock in a low interest rate environment. 
For mortgage holders, lower interest rates will also be welcome news.  The current mortgage interest rate, which is 1.25 percentage points below the level prevailing when the Coalition lost the November 2007 election, is expected to fall although there is some uncertainty about the proportion of cuts in official rates that will be passed on to consumers as banks struggle with a sharp increase in funding costs.
It is also apparent that the tight Budget delivered by the Gillard Government in May 2011 and reinforced in the Mid-Year Economic and Fiscal Outlook in November, is helping to keep inflation in check, with real government spending falling for the first time since the late 1980s.
Economists argue that these issues were important drivers of ratings agency Fitch recently upgrading Australia’s credit rating to triple-A.  This saw Australia achieve an unprecedented triple-A rating from all three major rating agencies.

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22
Jan
2012

Household Incomes – About to Get a Boost?

In the next little while, there are a few factors that will by themselves provide a boost to household incomes.  The most obvious is the boost from lower interest rates.  Already, most retail rates have been cut by 50 basis points or more which will free up cash flows for the still heavily indebted household sector.  There will be a small offset to this from the lower interest income on household savings but this is no big deal compared to the savings for borrowers.
And with more interest rate cuts coming, the cash flow for the household sector is about to get plenty of support.
There is also an imminent boost to household income from the Government compensation and tax changes that are being funding from the carbon price.  There’s around $500 million a month that will be paid to the household sector in the form of tax cuts or pension payment increases over and above any automatic pension increases.  If recent history is any guide, around 90% of this will be spent.
What’s more, the flood levy, which from memory raised around $1.75 billion in 2011-12, ends on 30 June.  For the medium to high income earners who paid this levy, there will be a material boost to take home pay by around $150 million a month.
All of which adds up to show that a mix of lower interest rates, tax cuts, pension rises and the end of the temporary flood levy will boost household income.
Of course there are some offsets to this otherwise rosy outlook.
Importantly, the slack labour market with fewer people employed means lower household incomes.  If you don’t have a job, you don’t earn any income.  Slower wages growth also crimps income growth.   These labour market issues will be the critical factor determining the extent of the interest rate cutting cycle and in a slightly circular argument, changes in household incomes and cash flows.
Inflation will also take away some of the household income boost.  We know there will be a 0.7% increase in the cost of living from the carbon price, so part of the compensation is merely a transfer – in effect – to cover the rise in prices that will come from the larger polluting companies.  Regular inflation, if we can call it that, should run at between 2 and 3% at an annual rate which will also account for some of the income boost.
The medium term outlook therefore shows some boost to household income to offset the problems from a weak labour market. 
For a good guide on just how this elaborate interplay of factors is impacting on the household sector, it will be important to look at retail sales, consumer sentiment, credit growth, loan arrears, motor vehicle sales and on a quarterly basis, most obviously household consumption.  Most of these indicators are weak at the moment, but there are reasons to be hopeful for an uptick during 2012-13.

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20
Jan
2012

Monetary Policy Delivers With a Long and Variable Lag

Interest rate cuts have been delivered by the RBA, and more are needed, because lower interest rates encourage households and businesses to borrow and invest and discourage households and businesses from saving. 
This is the most basic principle of monetary economics.
The RBA now knows that GDP growth has been mired for 3½  years below trend (estimated to be 3.0%) and has averaged just 2.0% per annum over that time.  It knows that because of this sub-optimal performance, employment growth is weak and jobs are now being lost.  It knows that fiscal policy is contractionary.  It is about to find out how inflation ended 2011 (the December quarter CPI will be released next week) with there being not much doubt that inflation will be comfortably within target. 
The RBA also knows that Australia needs a little more spending and investing and a little less household and corporate saving if growth is to move back to an even keel, if jobs growth is to return and if inflation is to be maintained with its target range.  The government sector is certainly not providing that impetus as the budget returns to surplus, so the RBA must weave its magic to underpin growth and employment in a low inflationary climate.
If consumers choose lower interest rates to pay off their mortgage faster, (they keep their repayments at a higher level), this is part of the mechanism of monetary policy working.  It’s deleveraging at least in the short term.  What’s more, at a time when house prices are falling, this approach would see the net equity position of mortgage holders being held up (and not falling – the disaster scenario) which means banks are unlikely to suffer from too many mortgage holders with low or negative equity.  It helps the banks as well as making mortgage holders more comfortable financially.  In time (this is the long and variable lag in monetary policy), hopefully these currently frugal mortgage holders will be so comfortable with their financial position that they will lift their spending and investment again. 
Is the alternative to hold interest rates at current levels which adds to risks of negative equity in houses, keeps mortgage cash flows on the border line and adds to economic uncertainty?  I think not! 
And if savings interest rates are crimped with official interest rate cuts, the incentive to save via bank deposits is lowered.  Why put money in the bank if you get a low return?  I might as well do something different with my money.  The incentive to spend is therefore a bit more is enhanced, and there is a greater incentive to look for alternative (ie higher returning) investments.  This may be in the form of householders providing capital via stock market investment, residential property investment (good for housing supply) or through higher yielding corporate bonds.  It helps the economy.
Any talk that lower rates will mean a cut in incomes from savers is most confusing and impossible to understand. 
As a counterfactual, should the RBA hike rates a few percentage points to boost savings incomes and therefore growth and job creation as deposit holders spend this extra money?  Absurd.
It’s niave to say that interest rate cuts wont work.  They will!  It’s just the speed and extent to which they work  – which is why the RBA meets so frequently to consider monetary policy.  It can jiggle rates one month, tweak them the next, go into emergency mode the next should conditions demand such action.  It can hike, cut or keep them steady with each decision aimed, in broad terms and over the longer run, at keeping GDP growth averaging 3%, inflation 2.5% and employment growth sufficiently robust to hold the unemployment rate at a low level.
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19
Jan
2012

>Last word on the lack of jobs report

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This will be the last word – for now – on today’s labour force release.

It is very rare for employment to fall in two straight months.

Since 2002, it has happened only six times.

Two of those back-to-back falls in employment have been since June 2011 – in the two months to August 2011 and now the two months to December (confirmed in today’s data).

Of the six occasions of consecutive monthly falls in employment, the most recent cumulative fall (-36,900) is the largest.

Three straight falls are even more unusual – since the early 1990s recession, it has happened only once (the three months to November 2000 as the terms of trade collapse and US tech-wreck was biting).

It would be a massive shock if employment doesn’t rise when the January data are released next month.

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19
Jan
2012

>Since the December RBA Board meeting …

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In the six weeks since the last RBA Board meeting, where it surprised a lot of people with another 25 basis point interest rate cut, quite a lot has happened.  The offshore news has been mixed – a slowdown has been confirmed in China, while the US has had better economic news, probably based on unseasonally warm winter.  Europe remains in the dumps, as are the UK, Canada and Japan.  Commodity prices have been a touch weaker.  This is probably as the RBA thought.
Locally, the news has been generally on the soft side.  Bank funding costs have not eased and have probably been squeezed higher.  What’s more, the Australian dollar is about 5% higher despite what has been neutral-to-bearish currency news. 
The RBA needs to cut interest rates at its 7 February meeting with a 50 basis point cut a non-trivial probability.  The December quarter CPI next week will be critical to the size of the cut.
In terms of a couple of issues dear to the RBA’s heart – when announcing the rate cut in December, RBA Governor Glenn Stevens noted in relation to the weaker parts of the economy:
  •  “changed behaviour by households and the high exchange rate have had a noticeable dampening effect.”

As mentioned, the Australian dollar is about 5% higher since then, consumer sentiment is markedly weaker and retail sales recorded no growth.  Hardly upbeat news when the RBA comes to consider these parts of the economy.
Mr Stevens also noted in December:
  • “with labour market conditions now softer, the likelihood of a significant acceleration in labour costs outside the resources and related sectors in the near term has lessened.”

Since then, 36,900 jobs have been shed, despite a 42,100 rise in the working age population.  What’s more, the participation rate has dropped 0.3 percentage points and aggregate work hours have fallen.
In other news, housing finance has ticked up, building approvals remain in the doldrums and house prices weak with a miniscule 0.1% rise in November after a year of straight decline.
And all of this with monetary policy only neutral and fiscal policy as tight as a python’s squeeze.
The February RBA Board meeting should be a doozie.  If, as seems likely, the December quarter CPI is low, probably negative, there will be a few Board members arguing for a 50 basis point cut.  They might prevail.  Such a view will only be reinforced by the rise in bank funding costs with there being no doubt that banks are under pressure to hike their retail rates.  As discussed before, the beauty of a 50 basis point cut it that there can be 20 or so basis points for the banks and 30 or so for consumers and business.  Everyone’s a winner in this scenario including the unemployed.

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19
Jan
2012

>Employment troubles – weakest performance since early 1990s recession

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For the first time since the recession in 1992, Australia has seen employment fall in a calendar year.  The fall in employment (100 people) in 2011 was confirmed with the uncomfortably large 29,300 drop in jobs in December which followed the 7,600 fall in November.   There was a favourable skewing towards full-time employment in December (up 24,500) while part-time employment fell 53,700, but this is not enough to change the view that the labour market is unambiguously softening. 
The spanner in the works for job creation is the participation rate, which slumped 0.3% to 65.2% – the last time the part rate was lower was in April 2007.  As a result, there seems to be a lot of people who could re-enter the workforce if economic growth were strong enough.  While a little bit dodgy, some people might suggest that if the participation rate had remained at the peak level of 66.0%, the unemployment rate would currently be around 6.25% (assuming all those dropping out of the labour force were counted as unemployed – as mentioned, a bit of a dodgy assumption but interesting nonetheless).
Either way, there is spare capacity building in the labour market at a rapid rate.  That spare capacity means that wages momentum will likely be skewed a little lower, further reinforcing the risks that the RBA will miss its inflation target during 2012 – on the downside.
All up, a disconcerting jobs report. 
That said, the labour market mushiness can be reversed.  The onus is squarely on the shoulders of the RBA to move monetary policy to a stimulatory setting which means lower rates at the 7 February meeting is essential.  As has been discussed here for some time, there is a good case for a 50 basis point cut which will be confirmed or otherwise with the CPI data next week and the run of monthly partials between now and the RBA meeting.  Maybe the RBA should have cut harder late last year when it was obvious growth was cooling and inflation falling.   Whatever.  But as mentioned, it can catch up now with some aggressive cuts.

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