Monthly Archives: April 2012

Mr Hockey offers up a bet, but will he follow through?

The Shadow Treasurer, Joe Hockey, said today that he “would bet everything in his pocket that the surplus [in 2012-13] will come from higher taxes instead of genuine savings.”

On Twitter, I asked Mr Hockey if he would be prepared to bet with me.  I haven’t heard from him yet, but here is how I reckon most people would benchmark “genuine savings” in the Budget.

There are two options:

1.     Use the growth in real Government spending (payments in Treasury speak) in 2012-13 as the benchmark.  Given that neither the Fraser nor Howard Governments in 20 Budgets ever delivered a single year where real government spending fell, a fall in real spending in 2012-13 would suggest some “genuine savings.”

So if real spending growth falls in 2012-13 (using the CPI as the deflator), I win the bet – if spending rises in real terms, Mr Hockey would obviously win.

2.     If Mr Hockey would prefer, we could use the Government spending to GDP ratio.

If the Government spending to GDP ratio in 2012-13 comes in below the average of the 12 Budgets delivered by the Howard Government (1996-97 to 2007-08 inclusive), I win, if it is higher than that average, Mr Hockey wins.

What could be simpler than that!

The bet would be finalised when the outcome for the 2012-13 Budget is released in August or September 2013.

The stakes:  

I don’t know what Mr Hockey has in his pocket, but can I suggest that rather than the contents, we either settle for a straight dollar amount, donated to a nominated charity or cause?  Mine would be Beyond Blue.

If Mr Hockey wants to tell me what he has in his pocket, I might consider it but I suspect the above option is safer.

Over to you Joe.

The House Price Fall Resumes in April

The RPData daily house price series confirm a 0.7% fall in house prices in April (end of month data, not seasonally adjusted) after prices were relatively flat (down just 0.1%) in the first three months of 2012.  In month-end terms, house prices have reached a new low for the cycle.

One aspect of the ongoing moderate house price falls that is welcome is more favourable affordability through market driven means.

The negative side of falling house prices are multi-layered.  Household wealth is being eroded which suggests less confidence and purchasing power.  Recall that nearly 70% of the people own (or are buying) their own house for living in, plus there are more than 1 million second, third, fourth and more houses owned by these people which magnifies the impact of any significant cycles in house prices on wealth and confidence.

For the banks, there is a slow but steady risk that more households drift into negative equity as house prices fall (in crude terms, anyone who bought a house n the last 2 years could be out of the money).  If this becomes more common, then the consumers under water with their finances stop spending; the banks losing money on mortgages restrict new lending and the economy stalls.  This is the worst case scenario.

Clearly, the RBA does not target house prices, but it does take note of house price trends for the consequences for the economy and the inflation outlook when it sets monetary policy.  Perhaps house pries have already fallen enough to sow a seed of concern about the risks of some economic stodge unfolding.  There seems to be some risk of this being priced in to bank funding costs and into the current yields in the government bond market.

Inflation Consolidates Near 2%

Australia’s monthly inflation indicator, the TD-MI Monthly Inflation Gauge, rose 0.3% in April following a rise of 0.5% in March to be 1.9% higher than a year ago.

The Inflation Gauge was early in picking the turning point in inflation in the middle of 2011 and was close to getting the magnitude of the deceleration in inflation right, even if for the March quarter itself, it gave a bum steer on the very low result for the CPI.

The run of momentum on the Inflation Gauge points to annual inflation running near 2% for the near term, a figure low enough to spark concerns that there could be a breach of the downside of the bottom of the RBA target if economic growth remains below trend for a little longer.  A breach of the inflation target on the downside is just as disconcerting as missing the target on the upside, meaning monetary policy can comfortably be eased tomorrow.

This extra snippet of news will be something to encourage those arguing for a 50 basis point cut.  Whether the RBA delivers 50 or 25 basis points tomorrow is unclear, but there is nothing in the recent run of data to suggest anything other than the cash rate dropping to 3.5% in the next few months.

Not a media release from the RBA – 1 May 2012

Not a Media Release

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

At its meeting today, the Board decided to reduce the cash rate by 50 basis points to 3.75 per cent.

Recent information remains consistent with the expectation that the world economy will grow at a below-trend pace this year, but does not suggest that a deep downturn is occurring. Several countries in Europe are in recession and Europe as a whole is expected to continue to record very weak outcomes.  The US economy is continuing a moderate expansion but has significant spare capacity, especially in the labour market.  Growth in China continues to moderate and is likely to remain at a more measured and sustainable pace in the future. Conditions around other parts of Asia softened in the first quarter of 2012 and some moderation in inflation has allowed policymakers in the region to ease monetary policies.  Commodity prices have generally been stable in the last month, but are noticeably off their 2011 peaks. Australia’s terms of trade have fallen appreciably since peaking in the September quarter 2011, but remain well above long run average levels.

Financial market sentiment has been less settled in recent weeks although capital markets are supplying funding to corporations and well-rated banks, albeit at pricing that reflects a premium for the current market uncertainty.  In the past month, wholesale funding costs have been stable, but at a level considerably higher than in mid 2011. The task of putting European banks and sovereigns onto a sound footing for the longer term remains large and while some tentative progress has been made, Europe will remain a potential source of adverse shocks for some time yet.

In Australia, the pace of economic expansion has been moderate and somewhat below expectations.  Indicators of economic activity suggest further below trend growth performance so far in 2012.  With a significant fiscal contraction in place, a pick up in private demand will be important in returning growth to trend.  Labour market conditions have remained soft in the first part of 2012, though the rate of unemployment has been little changed around 5.25%.

Interest rates for borrowers remain close to their medium-term average. Credit growth remains modest. Having stabilized in the early months of 2012, housing prices have resumed a moderate downtrend and new construction activity is particularly weak.  The exchange rate has remained high over recent months, even though the terms of trade have declined.

Inflation has fallen sharply over the past year, undershooting most expectations.  In underlying terms, inflation was below 2¼ per cent in the year to the March quarter 2012, a 13 year low. CPI inflation has fallen to around 1½ per cent as many temporary price shocks associated with natural disasters in early 2011 unwind.  Updated staff forecasts are for inflation to remain around 2 per cent through to the end of 2012 and to edge up to around the mid point of the 2–3 per cent range during 2013.  This forecast abstracts from the effects of the carbon price and also embodies an assumption that productivity growth in the economy increases somewhat as a result of the structural change now occurring.

Today’s decision of the Board was based on the Board’s judgement that, with growth below trend, inflation was expected to remain around the lower bound of the inflation target.  Less favourable conditions in credit markets were an additional factor in the decision to reduce the cash rate by 50 basis points.

Monetary policy has been moved to an accommodative setting.  The Board will continue to monitor future economic and financial conditions in considering any future adjustments in monetary policy but at all times, will set the cash at a level that will foster sustainable growth and low inflation.

Price falls help with purchasing power & the cost of living

When the CPI data were released earlier this week, Shadow Treasurer Joe Hockey issued a Press Release in which he noted:

• “The CPI has also confirmed the cost of key household items continues to outstrip average incomes.
• Over the year to the March quarter electricity rose by 9.9%, water & sewerage 9.3%, childcare 9.7% and petrol 5.9%.
• These are essential items that families cannot do without.”

That is true, there were large increases in the items that Mr Hockey cherry-picked from the CPI release.  It is interesting to note that, according to the weights in the CPI, the average household spends 2.2% of its income on electricity, 1.0% on water & sewerage; 0.7% on childcare; and 3.6% on petrol.  That means that the average household spends just 7.5% of their income on those 4 items mentioned by Mr Hockey.

Whatever the tick-tacking there, Mr Hockey ignored some of the other “essential items that families cannot do without.”

Below is a selective (yes, cherry-picked) list of items from the CPI whose prices have fallen over the past year, a time when average weekly earnings have risen by around 4%.

Annual % change

Oh and by the way, the weight of those items in the CPI basket totals 27.4%.

The bottom line is that the overall CPI rose 1.6% over the year, a very low rate of inflation with some items rising and some falling, like they always do, but on average, the price rises were small.

RBA Update – A Sub-3.5% cash rate is unlikely

Since about September last year, I have been of the view that the economic and financial market fundamentals would see the RBA cut the cash rate to 3.5% by around the middle of 2012.  I will stick with this view for now.  The issue jumping up at the moment is where to after that for interest rates in the latter part of 2012 and into 2013.

Based on recent data, a case is building that suggests the RBA may need to go below 3.5% over the medium term.  The market is close to pricing in a 3.0% cash rate for early 2013 and clearly, this is where the risks are.

That said, it will take a sharp rise in unemployment and a further drop in inflation for the RBA to move official rates back towards the depths of the GFC levels, which coincidently was 3.0%.

To be sure, inflation has undershot expectations by more than a full percentage point, house prices are continuing to fall (unlike that RBA assessment at the April meeting where they suggested “Housing prices have shown some signs of stabilising recently”) and the bulk of the activity indicators are soggy.  A tight Budget will also subtract from GDP growth in the year ahead.  A fragile world economy is, of course, another wild card.

These issues are likely to be neutralized or turned around with around 75 basis points more of interest rate cuts in the near term.  Something like 60 basis points of so will be passed on to mortgage and business loans meaning that monetary policy will be accommodative.  Mortgage rates, in these circumstances, would be of the order of 6.75% which should be enough to stem the weakness in housing.

For the RBA to go below 3.5% for cash, and therefore mortgages towards 6.5% or lower, there needs to be a meaningful rise in the unemployment rate (towards 6%) and another few quarters where underlying inflation muddles along near 2% or lower.

This may happen, but it seems to be more of a worst-case scenario that a core view.

For now, the RBA will be cutting the cash rate to 3.5% in the next few months which just might be enough to support growth and keep inflation in the target range.

Deflation on the RBA Menu?

The Statement accompanying the April rates-on-hold decision of the RBA concluded:

• “At today’s meeting, the Board judged the pace of output growth to be somewhat lower than earlier estimated, but also thought it prudent to see forthcoming key data on prices to reassess its outlook for inflation, before considering a further step to ease monetary policy.”

So what have the “key data on prices” so keenly sought by the RBA shown since that Statement.

• The consumer price index rose 0.1% in the March quarter (it fell 0.2% seasonally adjusted).

• The RBA underlying measure for the CPI rose 0.3% and annual inflation fell to a 13 year low of 2.1%.

• The producer price index fell 0.3% in the March quarter.

• Export prices fell 7.0% in the March quarter; import prices fell 1.2% in the March quarter.

• The RP Data house price series, up to an including today, has fallen 0.6% so far in April.

So there you have it members of the RBA Board.  Stunningly low price results at a time when credit markets are rupturing, growth is below trend and we are about to embark of the biggest annual fiscal contraction in more than 50 years.  The 50 basis point cut next week is just another step on the way to yet lower interest rates before the end of 2012.

Inflation: Dead, buried and in need of resurrecting

Underlying inflation has not been this low – 2.1% through the year – in 13 years.  Next quarter, when the 0.8% rise from June 2011 drops out of the annual run rate, it’s likely that underlying inflation will break below the bottom of the RBA target band of 2.0% and there’s a sporting chance it will fall to a record low of 1.8%.

Headline inflation has crashed to 1.6%, below the bottom on the RBA target band and has risen at an annual rate of 0.2% in the last 6 months!

Whichever measure of inflation you wish to use, inflation is massively lower than most forecasts from just 6 or 9 months ago which were skewed towards annual inflation accelerating to 3% or more.  In the second half of last year, some market commentators were even suggesting that Australia had a “major inflation problem” and that the RBA was well and truly “behind the interest rate curve”, meaning they expected 2 or 3 rate hikes in quick succession.

The fact that the inflation “problem” could be emerging on the downside and that there have already been 2 rate cuts with 100 basis points more priced in for the next year is a reflection of the all-to-easily dismissed anecdotes from retailers, manufacturing, the tourism and education sectors, housing, construction and basically anyone not attached to the mining sector.  Maybe they had a point when they were saying conditions were tough.

What we are seeing now in the inflation data is just how soft the economy has been.

Looking back at the reasons why so many people, including the good folk at the RBA, misread the inflation outlook, a couple of key issues spring to mind:

• Importantly, the level of the Australian dollar has had a more dramatic effect on activity and inflation than was generally assumed.

• The world economic environment remains fragile and is damaging sentiment, confidence and economic activity.

• Interest rates were actually quite restrictive through 2011 and the impact of that restrictive setting is showing up in current data.

• Fiscal policy settings and government demand are having a bigger than assumed dampening effect on activity.

• Falling asset prices in the form of weak stock market prices and falling house prices are poison for the economy.

The inflation result today is so low that it demands that monetary policy move to an accommodative stance as soon as possible.   In concert with the fall in the terms of trade and the fall in producer prices, the consumer price data should allow the RBA to get rates lower for the sake of growth, jobs and in doing so, avoid the threat of the Bank missing its inflation target on the down side in the next year or two.

The case for a 50 basis point cut – or more – is compelling.  There needs to be some catch up to take account of the low CPI in the December quarter which everyone seems to have forgotten, and the ongoing softer growth momentum in the economy right now.

Whatever amount the RBA cuts next week, it will not be passed on in full.  A 25 basis point cut would probably result in about 15 to 20 points being passed on to retail borrowers.  In this case, the level of retail rates would be virtually the same at they were at the end of 2011, a time when the RBA and others were still concerned about inflation, wages and were optimistic about improving financial market conditions.

Rates need to be lower than they were at the end of 2011 and the only way to achieve that is for the RBA to cut by 50 basis points (or obviously more), with the cash rate dropping to 3.75% and mortgage rates falling to around 7.0%.  The inflation data today and in the last week are low enough to justify such a move.

And there will be more rate cuts after that, given the RBA will have to play catch up and given the world economy and markets remain in a deep funk.

Politicisation of the RBA – Outcomes versus “Interference”

Like a chook scratching the ground for a speck of sustenance, my little mate Chris Joye has gone back 18 years, to 1994, to try to support one of his many conspiracy theories – this one, political interference in the workings of the RBA.

Mr Joye cites an example where Prime Minister Paul Keating managed to persuade RBA Governor Bernie Fraser that the rate hike in August of that year should be 75 basis points and not the 100 basis points that the Board was considering.

While Bernie Fraser may have been “disappointed” in the way that Mr Keating was involved in the deliberations of the RBA, it is vitally important to note that two months after that intervention, the RBA hiked rates 100 basis points and two months after that, it hiked interest rates a further 100bps, to an eye-watering 7.5%.

To this day, this remains one of the most concentrated and furious rate hiking cycles in Australia in modern times.

• 275 basis points of interest rate hikes in just 119 days.

In terms of the damage done to the inflation target by PM Keating arguing for a 75 bp hike and not a 100bp hike, well… there is none.

In that cycle, annual underlying inflation did not once exceed 3.0% and by September 1996 it was back at 2.5% and by September 1997, underlying inflation was below 2%.

Was that actually overkill with rates being too tight?  One could easily argue that Keating was right to be cautious on interest rates given the performance of inflation.

FOOTNOTE:

Consider the 275 bps of interest rate hikes in 119 days under Bernie Fraser and Paul Keating.  Result – inflation contained, as indicated above.

Consider now the RBA error which saw underlying inflation average 4.0% in the period 2007 to 2009 with a peak rate of 5.0%.   It took the Coalition appointed RBA Board, answerable to Treasurer Peter Costello, 2,128 days to hike rates 250 bps and clearly they got it wrong.

Producer Prices Fall

Final producer prices fell 0.3% in the March quarter after rising just 0.3% in the December quarter to be 1.4% higher than a year ago.

Producer prices give some guidance to future more general inflation pressures although the direct link to the CPI in the short run is not particularly strong.  That said, disinflationary producer prices are important for the overall assessment of inflation risks over the breath of the economy and the RBA obviously take account of such prices in assessing monetary policy risks.

Recent price data on the terms of trade last Friday and today for producers, are screaming for a move to accommodative monetary policy – and soon.  The terms of trade have fallen almost 10% over the last 2 quarters and now producer prices are weak and smashing below the expectations of the market and no doubt the RBA.

If the consumer price index tomorrow comes at expectations – 0.8% for the headline CPI and 0.6% for the underlying measure – a 50 basis point rate cut will be debated with gusto at next week’s meeting of the RBA Board.  If the CPI comes in lower than these expectations, a 50 basis point cut next week would seem prudent.