The Australian Pulls Recession Talk Out of its Bum

Here’s a new one – the fiscal tightening in the May Budget risks the economy falling into recession.   A recession in Australia! Because of fiscal policy!

Well, that’s the out-of-your-bum headline from The Australian today.

Here it is:

“PM rejects there’s a risk economy could slide into recession as a result of budget cuts”


Can anybody seriously suggest that the Australian economy is about to “slide in recession” for any reason at all and yet more absurdly suggest that fiscal policy will cause it?

Posted in Stephen Koukoulas | Leave a comment

There’s More To Life Than The Budget

There are many misunderstandings and misinterpretations of the fiscal policy strategy of Treasurer Wayne Swan and the Government.  That strategy is summed up in the notion that the Government will return the budget to surplus in 2012-13.

A lot of it is coming from people and commentators who should know better.

Much of the commentary questions the economic imperative of returning the Budget to surplus when the economy is muddling along at a below trend growth rate, when employment is weak and inflation so well contained.  This focus is where the misunderstanding occurs.  It is as if fiscal policy as is the only policy lever in town.  It isn’t.

Monetary policy is usually not discussed by those bagging the Government’s economic objective in delivering a surplus next year.

It must be considered.

In the most basic of basic terms, the tighter fiscal policy is, the easier monetary policy can be.  Simple.  And vice versa as Peter Costello knows form his last few years as Treasurer when government spending grew at a rate that would make Frank Crean blush.

The Government at the moment is part way through delivering the most dramatic bottom-line turnaround in fiscal policy since at least the 1960s.  It is cutting real government spending for the first time since the 1980s.

And think about this context.  Recall the 2010 Budget.  It was the one where the Government announced the return to the budget to surplus in 3 years (2012-13 as it was then) and 3 years early (the earlier path was to get back to surplus in 2015-16).

This bring forward in fiscal restraint was announced at a time when the RBA had set the cash rate at 4.5%.  The futures market was pricing in a cash rate around 5.5%.  With the Government doggedly holding on to the fiscal objective in the 2 years since, the RBA hiked interest rates once (in November 2010 to 4.75% as global conditions improved); and since then has cut rates twice to the point where they currently sit at 4.25%.

It is no accident that interest rates are lower now than when the government announced its decision to turn the screws on fiscal settings.  It is also no accident that in the wake of the fiscal tightening going on right now and confirmed by Swan yesterday, that the interest rate futures market is pricing in 3 more rate cuts – to a level of 3.5% – by early 2013.

The trade off is there for all to see.

So beware looking at the fiscal policy approach of the Government in isolation.  There’s much more to lfe and managing the economy than a few spending and taxing decisions.

Posted in Stephen Koukoulas | Leave a comment

Not the RBA Media Release for 3 April: It’s a 25bp cut

Not a Media Release




3 April 2012


For Immediate Release

Not a Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to reduce the cash rate by 25 basis points to 4.00 per cent.

Recent information is consistent with the expectation that the world economy will grow at a below-trend pace this year, but recent information suggests that that a deep downturn is unlikely. Several European countries are recording very weak outcomes, but the US economy is continuing a moderate expansion but with significant amounts of spare capacity. Growth in China has moderated and inflation is falling sharply – policy has been eased. Conditions around other parts of Asia remain firm, although activity, on average, is moderate.  Some lowering in inflation has allowed policymakers in the region to ease monetary policies somewhat.  Commodity prices have been broadly flat in recent weeks, but are below the peak levels recorded during 2011.

The acute financial pressures on banks in Europe have been alleviated considerably by the actions of policymakers, though there is more to do to put European banks and sovereigns onto a sound footing for the longer term and Europe will remain a potential source of negative shocks for some time yet. Financial market sentiment has continued to improve in recent months and capital markets are again supplying funding to corporations and well-rated banks, albeit at costs that are higher, relative to benchmark rates, than in mid 2011.

Information on the Australian economy has been mixed, with the national accounts confirming that overall economic growth in 2011 was below trend.  Partial indicators for the early months of 2012 point to ongoing moderate growth rather than an acceleration in activity.  This means that an output gap is starting to open which, in time, will dampen inflation.  Labour market conditions remain soft, although the unemployment rate remains relatively low around 5¼ per cent. CPI inflation is forecast to remain around 2½ per cent with risks moving to the downside given the sub-trend growth rate and softer labour market conditions.   Looking forward, fiscal policy will impart a further contractionary influence on economic activity.

Interest rates for borrowers remain close to their medium-term average. Credit growth remains modest. Having declined through the course of 2011, housing price falls have moderated, while dwelling construction remains weak. The exchange rate has been reasonable steady in recent months, albeit at a high level, even though the terms of trade have declined.

With growth below trend and inflation close to target, the Board judged that a further moderate cut in the official cash rate to 4.00 per cent to be appropriate.  The Board will continue to monitor information on economic and financial conditions and adjust the cash rate as necessary to foster sustainable growth and low inflation.

Posted in Stephen Koukoulas | Leave a comment

Swan Delivers a Powerful Message

Treasurer Wayne Swan has confirmed, in his speech this morning to the Australian Business Economists, that the Government will deliver a strong contrationary bias to public demand in the Budget.  This contraction will not just be concentrated in 2012-13 but will continue into 2013-14, an important fact for the market and RBA Board members to contemplate.

Of huge significance, Swan’s very clear message to the RBA is that it can easily cut interest rates knowing that government demand will be dampening demand and inflation pressures over the forecast horizon.  This message is now filtering through to foreign investors in Australian markets which is seeing the Australian dollar take a few steps lower as the carry trade loses some of its appeal.

Here is some of what Swan said:

  • “our fiscal strategy ensures we won’t be adding to the price pressures of a strengthening economy experiencing a once-in-a-generation investment boom…”
  • “The IMF also acknowledges a surplus, and I quote, “will increase fiscal room and take pressure off monetary policy and the exchange rate”.”

See the logic?

It’s a near perfect application of economic policy.  Tighter fiscal policy which builds savings, giving even great fiscal flexibility for the future, allows for a lower interest rate structure and therefore a lower Australian dollar.

Recall the alternative is an easy budget with on-going deficits, higher interest rates and an even higher Australian dollar.  Lovely.

It is often forgotten that government demand makes up around 20% of GDP.  As such, it is 4 times bigger than all housing investment; it is not much smaller than all of retail sales combined.  What happens to government demand has a big impact on the overall growth performance of the economy.

The Budget measures will confirm Australia has a recession in government demand.  This will free up resources to allow the private sector to grow and expand.  The private sector will be aided by lower interest rates and a more competitive exchange rate.  The government sector’s demand on workers, finance, resources will be lower with tight fiscal settings, which allows for those resources to be taken up by the private sector.

There are some commentators suggesting that the economy is so soft or vulnerable that the Government should abandon its economic objective of returning to budget surplus.

These calls are embarrassing for the proponents as they underscores a lack of appreciation of the policy objectives, as indicated above. 

They must recall that the cash rate in Australia is 4.25% – a long way from the zero bound in so many other countries at the moment.  There is plenty of scope for the cash rate to be lowered.  The RBA could cut to 3.5%; 2.5%; 1.5% if needed.  What’s wrong with this as a measure to support activity?

Those arguing for the Budget surplus objective to slip are implicitly arguing for higher interest rates and an even higher Australian dollar.  I suppose that is fair enough if they acknowledge the consequences of their suggestion, but given the terms of trade are falling and the Australian dollar is still high, such a move would drive an even greater imbalance within the economy.

If I was recommending market trading strategies, AND I AM NOT IN THIS INSTANCE, I would be getting set for the RBA to be cutting interest rates aggressively in the next few months – a 3.5% cash rate remains on the cards in the next few months.  In this climate of what are currently unanticipated rate cuts, the Australian dollar is long overdue for a fall.  With the carry trade losing some of its carry as the RBA cuts rates, a nice 5 to 10% fall in the dollar could be seen by year end.

Posted in Stephen Koukoulas | Leave a comment

RBA to Deliver the February Interest Rate Cut in April

The February interest rate cut will likely be announced next week, on Tuesday 3 April.   Arguably, the RBA should be cutting rates again next week (that is, taking the cash rate to 3.75%), but it would be too much to expect the non-staff on the Board to be swayed to take what now would be an aggressive move.  It is likely to take the cash rate below 4% in the months ahead.

The on-going sub-trend rate of economic growth, low inflation, moderate wages increases, confirmation the Budget will lock in a contractionary period for government demand and the ongoing strong and overvalued Australian dollar should see the interest rate cut delivered.

The papers and recommendation for monetary policy for the RBA Board meeting are close to the sign off stage at Martin Place.

Since the March RBA Board meeting, the data flow has confirmed that GDP undershot the RBA’s already downgraded forecast by around ½%, employment fell again, consumer and business confidence remained weak and asset prices are pretty flat.

In addition, the global environment remains problematic – in the last few weeks, China has revised down its growth target and further eased policy and Europe remains in recession, but this has probably been partly offset by better economic news out of the US and reasonably calm market conditions.

An interest rate cut next week will hardly ignite inflation pressures – but it will provide a small kick-along for growth and confidence.

Posted in Stephen Koukoulas | Leave a comment

Mr Hockey Proposes 30 year Government Bonds

Shadow Treasurer, Joe Hockey, has indicated that in Government, the Coalition would consider issuing 30 year government bonds

  • “to create a benchmark for in particular infrastructure investment”.

This objective sits oddly with the Coalition’s opposite objective, articulated so very well by Shadow Ministers Andrew Robb and Barnaby Joyce – that a Coalition Government would pay off debt.

According to Mr Robb, the Shadow Minister for Finance, Deregulation and Debt Reduction (my emphasis):

  • The top priority for a Coalition government would be slashing debt.”

Mr Robb added:

  • the government should be paying down debt.”

Mr Joyce, the Shadow Minister for Regional De elopement, Local Government and Water recently said:

  • we should be paying our debt down not blowing it out through the roof.”

So what it is?  Will the Coalition “pay down” and “slash” debt, or will it issue 30 year government bonds to lock in Government debt levels out until the middle of the century?

There are also questions for Mr Hockey about what the Coalition, in Government, would do with the money it raises by issuing bonds for 30 years?  Will it use the money for its own infrastructure requirements?  Will it borrow for 30 years to fund what are currently unfunded promises on tax and spending?

Mr Hockey says a 30 year bond would be a “benchmark”.  This implies, but is by no means certain, that a 30 year government bond would be a market indicator that would allow the corporate sector to issue bonds of similar duration.  In other words, it would be a pricing benchmark for other issuers of bonds.  This is odd given how under-developed the current corporate bond market is in Australia, even out to 10 years.  I can’t imagine too many corporate issuers of bonds wanting to go out 30 years even with a government bond to benchmark pricing.

In issuing bonds out to 30 years, would Mr Hockey propose to reduce the amount outstanding in the shorter dated bond lines?  If so, does he have any concerns about strangling liquidity in these other lines?  If not, does that mean that debt would actually increase?

It will be interesting to see what, in the end, the Coalition comes up with in this space.  As it stands, it is very confusing and not the stuff that will calm markets.

Posted in Stephen Koukoulas | Leave a comment

Fancy another $13,000 a year in your pocket?

There is a lot of hysteria and outrage about cost of living pressures.  Electricity bills are rising by $400 a year.  The price of petrol is up 10 cents to $1.50 a litre, which means a tank will cost you $6.50 more.  The price of tobacco has also risen strongly which is “bad for struggling working families” especially with the average household spending more on tobacco than they do on electricity – not that you’d ever hear that reported.

Often forgotten in the discussion of cost of living are the falling prices for things like milk, clothes, shoes, household appliances, cars, TVs, computers and overseas holidays.

According to a Newspoll exit poll from the Queensland election, a staggering, unbelievable, 69% of people suggested cost of living pressures were an important factor swaying their vote.  I assume this means they voted for the LNP and not Labor!

This is extraordinary and shows how perceptions matter much more than reality.  And the Labor Party is as guilty as the Coalition in fuelling this mistruth with their oft repeated “families doing it tough” efforts to get on side with voters.

There are a couple of issues with this strategy – importantly, it is factually incorrect.  Second, it is tantamount to talking down the economy, adding to consumer disaffection and creating an impression that the Government is not delivering good outcomes to the people.  If the Government is telling me I am doing it tough, I must be – and it’s their fault.

Let the Opposition talk down the economy, but for the Government to do it is one important reason for the current poll results.

So let’s look at some facts.

What is always forgotten or frankly ignored when looking in what is happening to the cost of living is the other side of household cash flows – wages.

In the 4 years through to the end of 2011, average earnings per worker rose $8,216 from $45,556 to $53,772 per annum.  This includes those working part-time.  For an average full-time worker, average earnings rose $12,029 over that 4 year period.

For the sake of discussion, I will use the overall average earnings figure – that is, an extra $8,216 over the last 4 years.  If we assume the tax take is at the marginal 30% rate (plus the 1.5% Medicare levy), it means an average worker takes home an extra $5,628 a year AFTER TAX than they were 4 years ago.

Now let’s work on the assumption that there are two workers on average incomes in a household – it could be one full-time and one-part-time – or just two average income earners; whatever.  This assumes average household income at the end of 2011 is around $107,544 per annum – a figure that is probably close to the mark if we use the less timely household income data which, by the way, also has a different coverage.

The important thing to note is that this household is taking home over $11,200 a year more – yes, in after tax dollars – than they were just 4 years ago.

Let’s also work on an assumption that this average household has an average mortgage of $300,000.  At the end of 2007, there were paying 8.55% interest.  Now, they are paying an interest rate of around 7.4%.  This means an interest saving of $228 a month or $2,740 a year.

Let’s do some simple cash flow analysis.

The extra “available cash” of this average household has increased by around $13,000 a year.  This clearly is much more than is being eaten away from higher prices for electricity, tobacco or lamb. 

Just to cross check this – since the end of 2007, average earnings have risen by 18.0%:  the consumer price index, which of course includes all items that go up (like electricity) and down, has risen by 12.1%.  The purchasing power of someone on average wages has therefore risen by around 6%. 

So please no more crocodile tears.  Australian consumers are doing very well indeed.

Posted in Stephen Koukoulas | Leave a comment

The Chinese Slowdown Intensifies as the RBA Fiddles

The Chinese Manufacturing PMI Index fell to 48.1 points – locking in 5 straight months of contraction.  It is not good news for Australia’s largest export market to be showing signs of such an abrupt cooling in activity.  Little wonder the Australian dollar fell sharply in reaction to this news and interest rate futures priced in a little more in the way of interest rate cuts in the next 6 to 12 months.

In Australia, 2012 started with snippets of economic news showing generally weaker activity, downside global risks and ongoing low inflation. 

Australian markets were pricing in a further rate cuts, with a rate around 3% priced in for the middle to latter part of 2012.  The cash rate stands now at 4.25%.

Since then, the economy news has tended to deteriorate.  GDP growth has stalled at a pace well below trend; employment is flat at best; consumer sentiment has weakened and house prices continue to ease.  About the only good news has been confirmation of the ongoing boom in business investment which is driven in large part by the mining boom.

From overseas, the recession in Europe is unfolding broadly as expected, although very recent news suggests it is no worse than feared.  At the same time, the news from the US has been noticeably more favourable with signs of a turn in housing, a run of solid jobs reports and share prices have been moving higher.  This is good news.  It is a very different story from China where the economic news has been unambiguously pointing to softness with a downgrade of the government’s growth target, weakness in manufacturing and a stalling in demand and prices for some commodities.

As discussed previously, the RBA needs to be more realistic about the current performance of the economy and the risks in the outlook.  It needs to take monetary policy to a more accommodative stance.  The April meeting of the RBA Board presents an opportunity for rates to be cut.  A balanced view of the economy suggests a rate cut should be certain, especially as the RBA failed to act in February and March and the news since then has been quite poor.  But it is not clear whether the RBA can divert is gaze from the mining boom and look at the rest of the economy and move rates lower.  We’ll see in a couple of weeks.

Posted in Stephen Koukoulas | Leave a comment

The Urgency for an Interest Rate Cut Intensifies

Some of the reasons why the RBA needs to cut interest rates and cut soon were outlined in the Op Ed piece published in the AFR today (  http://alturl.com/kwngb  - a full version reproduced below).

In addition to what should be obvious economic indicators such as sub-trend economic and employment growth, entrenched low inflation and an increasingly over-valued Australian dollar, we are now starting to see the impact of a softer Chinese economy coming through in corporate news.

In recent weeks (and most noticeably since the March RBA Board meeting), China has lowered its growth target to 7.5%, while BHP and other mining companies are highlighting a flattening in demand for minerals and energy from Chinese importers.  Prices for some of these commodities is also softening.

Broad global commodity price indices remain soft, particularly in Australian dollar terms, suggesting that inflation pressures are neutral at worst and probably actually skewed to the downside.

In being reluctant to cut interest rates in this current cycle, the RBA has placed a massive amount of importance on the mining industry and China.  As outlined in my Op Ed article today, this over-cooking of the mining goose is leaving the whole economy in muddle through mode, rather than moving along at a pace nearer potential.

If the RBA remains true to its faith on the importance of mining and China, the recent news will only magnify the need for rate cuts.

A 3.5% cash rate remains on the cards for sometime in the next little while, but the longer the RBA holds off delivering those cuts, the greater the downside risks to that outlook – ie, even more cuts will be needed.


Why RBA needs to cut rates


In the past year, the Reserve Bank of Australia has made an error by placing too much weight on the mining boom and the overheating in that sector. At the same time, it has underplayed the weakness in the rest of the economy, which has been constrained by the strong Australian dollar, the substantial fiscal policy tightening, restrictive interest rates and global issues. Interest rates have remained higher than would have been the case had the RBA given more weight to the negative influences and scaled back its magnified optimism on mining.

Economic growth in 2011 was an anaemic 2.3 per cent, bringing the period of sub-3 per cent growth to nearly four years. At the same time, underlying inflation fell to an annualised rate of 2 per cent in the final six months of 2011 and employment growth stalled.

Financial markets think the RBA has held monetary policy too tight for too long as shown by the fact that the yield curve is trading below the cash rate, the Australian dollar is strong despite less favourable fundamentals and shares are underperforming their global peers.

The reluctance of the RBA to cut interest rates further is surprising given the spectacular back-tracking on its gross domestic product forecasts in 2011. In February 2011, the RBA forecast GDP to rise by 4.25 per cent through 2011 and by 4 per cent in 2012. This is why it had monetary policy at a restrictive level. By August, the RBA massively scaled back its growth forecasts to 3.25 per cent for 2011, but it held the 3.75 per cent forecast for 2012. This looked optimistic but the RBA held to its view the mining boom would underpin above trend growth.

In November and December, the RBA cut interest rates and had to acknowledge a further downgrade to its GDP forecasts, this time to just 2.75 per cent and 3.25 per cent, respectively, for 2011 and 2012. The concern now is that these massive revisions have not gone far enough. The recent national accounts confirmed this with growth in 2011 of just 2.3 per cent.

The RBA’s forecasting error extended to underlying inflation, which it forecast to rise 3.25 per cent through 2011. In the event, it rose by only 2.5 per cent. Despite these dramatic downward revisions, the RBA has cut interest rates just 50 basis points with less than that flowing to borrowers.

By not cutting rates this year, the RBA has undermined confidence, restricted credit growth, and locked in an unnecessarily long period of economic underperformance. Business and consumer sentiment are weak and the near-term outlook for the economy is problematic.

The RBA can address this easily by lowering official interest rates to ensure the economy does not have to deal with another year of sub-trend growth. An interest rate cut in April would be a good move.

Stephen Koukoulas is managing director of Market Economics and was economics adviser to Prime Minister Julia Gillard.

Posted in Stephen Koukoulas | Leave a comment

Julia Gillard Moves to 19

Tomorrow, Prime Minister Julia Gillard will become the 19th longest serving Prime Minister in Australia’s history clocking up 1 year and 271 days in office.

Of Australia’s 27 Prime Ministers since 1901, Ms Gillard has served a longer time in office than McMahon, Cook, Reid, Watson, Fadden, McEwen, Page and Forde.

By this time next year, she will have overtaken Holt, Scullin, Rudd and Barton and move into 15th place.

If the election is held after 24 August 2013 (get set for an October 2013 poll in my view) and even if she loses, Ms Gillard will have then overtaken Whitlam and Gorton and become the 13th longest serving PM.

Posted in Stephen Koukoulas | Leave a comment