The RBA Will Wait for Q1 CPI Data Before Cutting Rates in May

“I wondered why the baseball was looking bigger and bigger.  And then it hit me.”

This could well sum up the decision of the RBA today to leave rates on hold for an extra month.  With the run of soft economic data coming at it faster than a Babe Ruth slug over left field, the RBA has said it will wait until it sees the March quarter CPI before cutting in May.

An odd decision to wait for a number that will show the average price of a basket of goods and services in January, February and March and divide that number by the average price of those same goods and services in October, November and December 2011 to set interest rates that will impact on the economic and inflation in late 2012 and into 2013.

I gave the RBA more credit for being pre-emptive and looking at forward rather than lagging indicators when deciding monetary policy.

I guess we could also look at the RBA decision in this context:  

  • If the underlying CPI comes in at 0.4% or less, the RBA can cut 50 basis points – after all, the annual rate of inflation will be heading to a number with a “1” handle and the economy is not getting any help from the AUD or fiscal policy (more on that below).
  • If the underlying CPI comes in at 0.5% to 0.8%, it will cut 25 basis points.
  • An underlying CPI above 0.9% would probably justify its “on-hold” decision.

I was wrong thinking that the RBA has enough information to cut interest rates today.  But it is hard to get past the notion of almost 4 years of GDP growth averaging only a touch above 2%; where job creation has stopped; where inflation is locked around the middle or lower part of the target; and house prices are so very weak; that the RBA wouldn’t edge rates a little lower.

There was a notable gap in the RBA commentary today.  There was no mention of a part of the economy that is one-fifth of GDP – double the size of mining, four times bigger than housing construction, about the same size of the retail sector – that is government demand.

Like it or not, government demand will be cutting GDP growth next year. 

Whatever the RBA Board may think of the Budget, it clearly does not share the view of parts of the business sector, some scaredy-cat columnists and many market economists that the fiscal policy strategy of the Gillard Government will drive the economy or parts of it into recession.

If the RBA thought this was even a rough chance, it would have cut interest rates today.  

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What’s the Surplus Alternative?

There are many commentators suggesting that the Gillard Government’s objective for a Budget surplus in 2012-13 is inappropriate given the economic outlook.

I have read a lot of that commentary and have not seen one of them, not one, suggest what their target for the deficit would be.  Is it a deficit of 0.2% of GDP?  0.5% of GDP?  A puny 1.0% of GDP?  2.0% of GDP?  Come on, say it.

None of them have mentioned what the abandonment of the surplus objective for 2012-13 would mean for interest rates and the Australian dollar.  I can only assume their deficit tolerance would fit perfectly with a higher interest rate structure and an even higher Australian dollar than we are seeing now.

As a result, none of the commentary suggesting that the surplus objective is wrong is worth a cracker. It is useless analysis.

Until I see one of these commentators say what the Budget deficit objective would be,what their deficit strategy would mean for interest rates and the Australian dollar, I and all others should treat their views with the disregard and contempt they deserve.

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One-eyed Economists: 99 is not the same as 100

The overwhelming consensus of market economists seem to be saying the Government should relax about the budget surplus objective in 2012-13 and be happy with a deficit.  At one level, this is fair enough, but when you look for some basic analysis of why this should be the case, there is a lack of detail on the consequences for this prescription.

No economist that I have seen is saying what the target for the budget deficit should be for 2012-13.  As I wrote yesterday, would a budget deficit of 0.2% of GDP be acceptable?  Why not 0.5%?  Or let’s go for 1% of GDP because the economy is really soft?  Hey, why not 2%? 

See the problem?  They bag the policy objective of moving to surplus without offering an alternative.  Not the policy advice that any Treasurer or Prime Minister would tolerate for a minute.

And then there’s the classic own-goal.  There is the almost unanimous comment that, from a macroeconomic perspective, a deficit of a couple of billions of dollars is all but the same as a surplus of a couple of billion dollars.

That is absolutely and utterly correct in our almost $1.6 trillion economy.

So why then, pitch for the deficit?  If the macroeconomic impact is the same, why go for the soft option of a deficit and not go in a bit harder and get that surplus?  After all, the macroeconomic impact is all but the same.

It’s like saying to a batsmen, who bats beautifully and finesses a gorgeous innings against the best bowling attack in the world that you will declare the innings with him on 99 not out.  After all, he’s done well, the team is in a winning position and hey, 99 not out is basically the same as 100. 

No it isn’t… and nor is a deficit of a few billion the same as a surplus of a few billion.

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Monthly Inflation Ticks Higher as Manufacturing and Construction Fall

The TD-MI Monthly Inflation Gauge shows that inflation pressures may have edged up since the start of the year, although it must be noted that some of this is seasonal. 

The Gauge rose by 0.5% in March which follows rises 0.1% in February, 0.2% in January and 0.5% in December.  The momentum on monthly inflation suggests that the official CPI for the March quarter will rise by 0.8%, which when seasonally adjusted, will be around 0.6% or so.  This would be a result consistent with inflation remaining at or maybe a touch below the mid point of the RBA target.

In other economic news today, the manufacturing PMI fell to 49.5 points – consistent with that sector flat-lining with near zero growth.  It is not good news.

Even more disconcerting is the 7.8% collapse in building approvals in February in seasonally adjusted terms which translates to 15 long months of decline in trend terms.  The number of building approvals in February is a painful 34% lower than the recent peak level in March 2010. 

All up, this news suggests that policy settings are too tight.

For the fiscal side of policy, it will remain tight whether you like it or not.  Get with the program – it will be a tight budget.

Monetary policy, on the other hand, has glorious flexibility.  The RBA Board meeting tomorrow could cut interest rates by 25 basis points – or more – with there being precious little chance of a disconcerting inflation blow out.  On the contrary, a rate cut might actually lessen the risk of inflation falling too far over the year ahead, a result which is as uncomfortable as missing the inflation target on the high side.

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