GDP growth booms & crashes: Jobs Surge


These were an extraordinary set of national accounts and labour force data.

BOOM!  In real terms, GDP grew by 1.3% in the March quarter for an annual increase of 4.3%.

CRASH!  In nominal terms, GDP rose a paltry 0.3% in the March quarter after a 0.3% rise in the December quarter meaning annualized growth over that period of about 1.25%.

Employment rose – again – and the unemployment rate continues to hover around 5 to 5.25%.  This is more in the middle, but a very pleasant result as well.

Which of these results matters?

As the terms of trade fall away, we are likely to see more of the same – resilience in the real GDP side of the economy but weakness – perhaps severe – in the national income side of the economy.

What matters for the RBA is the nominal side of the economy – that is, the bit that takes account of inflation.  The RBA is an inflation targeting central bank and now we have all measures of inflation at no more than 2.1% and from the national accounts, many are around a 0.5% to 1.0% pace.  With an inflation target of 2 to 3%, the RBA is (or rather was) over-egging the cake.

It is also the nominal side of the economy that matters for profits, incomes and the budget.  These are all soft, notwithstanding the blockbuster growth in real GDP.  The overall rate of economic expansion has, nonetheless, fed into demand for labour with employment growth kicking higher after a flat patch in late 2011 and early 2012.  This is arguably as important as the GDP result for checking the inflation risks for the economy and given the strength in both sets of data, the downside risks to future inflation pressures have also clearly abated.

Despite this run of massively better news, share and house prices remain weak, global markets have ruptured, which is likely a concern.  Thankfully, the RBA has cut official rates by 75 basis points in the last two month, but the government has gently tightened fiscal policy all of which means the economy is entering a period that will be particularly difficult to read.

Until now, the economy was meandering along below potential and one must recall that around 0.5 to 0.8 percentage points of the 4.3% annual growth in GDP in the year to the March quarter is a function of the June quarter 2011 growth rebound after the Queensland floods.  Next quarter, a 0.8% quarterly growth rate will drop annual GDP to 3.5%.  Still good, but not as spectacular as 4%.

The RBA looks set to sit tight in July – it has caught up nicely to the previous period of sub-trend growth with the 75 basis points of rate cuts in the last 2 months and it has been dealt some pleasantly firm local news.

In a funny quirk for fiscal policy, the next few months are likely to be quite stimulatory with personal payments, the ending of the flood levy and other areas where spending has been brought forward adding to demand.  This is likely to boost upcoming data which will again work against further RBA action.

The fiscal contraction for 2012-13 is still there but its greatest contractionary force is likely to be in the December quarter and beyond – hopefully not when the global economy is spirally into the abyss.

The RBA knows all of this, even if many in the markets don’t.  That’s why they cut and why more cuts are still much more likely than not.

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RBA cuts 25 to 3.5%


The RBA did the right thing and cut interest rates by 25 basis points to 3.5%, but in doing so, it is signaling its new-found alertness to downside risks in the economy and inflation.

The key quotes from the Statement of RBA Governor Glenn Stevens are below, with my comments in square brackets and in italics.

  • Growth in the world economy picked up in the early months of 2012, having slowed in the second half of 2011. But more recent indicators suggest further weakening in Europe and some further moderation in growth in China.  [The recent indicators of moderation are the fresh concerns for the RBA – as they should be.]
  • Commodity prices have declined lately, though they are mostly still high.   [Interesting use of the word “mostly”.  The broad global commodity price indices are very weak and are a sign of disinflation pressures globally.]
  • Financial market sentiment has deteriorated over the past month.  [Bingo!  This is fresh news that made the rate cut inevitable.  Watch markets for more clues on where to next for the RBA.]
  • Capital markets remain open to corporations and well-rated banks, but spreads have increased. [Meaning banks will not pass on the full 25 basis points and will probably face funding cost pressures in future.  This also means further rate cuts are near certain.]
  • In Australia, available indicators suggest modest growth continued in the first part of 2012.  [Modest is just that, modest.  Stevens could have said “subdued”, or “moderate” either of which would be consistent with ongoing low inflation from a low starting point.]
  • Both households and businesses continue to exhibit a degree of precautionary behaviour, which may continue in the near term.  [“Caution” means holding off spending, borrowing and investing.  Lower interest rates may change that cautious approach.]
  • Maintaining low inflation over the longer term will require growth in domestic costs to slow as the effects of the earlier high exchange rate wane.  [This is the one hawkish part of the statement – imported prices may edge up as the AUD remains lower than it was at the start of the year.]
  • Housing prices had shown some signs of stabilising around the turn of the year, but have recently declined again. [Falling house prices can move from rancid to poison very quickly… not that the RBA targets house prices but it would be worried if there were on-going large price falls.]
  • At today’s meeting, the Board judged that, with modest domestic growth and a weaker and more uncertain international environment, the outlook for inflation afforded scope for a more accommodative stance of monetary policy. [There seems little doubt the RBA will need to cut some more in the months ahead.]
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Me in the AFR: Still on target for budget surplus


My Op Ed article in today’s AFR is here:


The budget is less than a month old and there is a perception unfolding that the projected surplus for 2012-13 is under threat due to the deterioration in global economic conditions and the associated ruction in financial markets.

To be sure, weaker than projected conditions in the global economy may yet undermine government revenue, risk higher spending and result in the budget slipping into deficit. This was always the case, just as a stronger than projected world economy would deliver extra revenue and a larger surplus.

Before there is any concession on the budget bottom line for 2012-13, it is worth delving into some of the facts that Treasury used to construct its economic forecasts for Australia and, with them, the projected levels of government spending and taxation.

Probably of most importance for now are the global growth projections. At the time the budget was framed, Treasury clearly erred on the pessimistic side for the global economy as it was factoring in a decline of 0.75 per cent in euro area gross domestic product and it was projecting 2 per cent GDP growth in the United States.

Both of these forecasts were below the general consensus at the time but are now looking increasingly prudent. The deterioration in these two parts of the global economy are more or less as Treasury was forecasting.

Put another way, the decision of Treasury to tilt its global forecasts to the downside means there was some “fat” in the projections for the economy and, implicitly, the fiscal side of the budget. There are other important issues in the framing of the budget that are relevant to the perceptions of a fiscal deterioration.

As is the usual budget practice, Treasury made the technical assumptions that the Australian dollar would remain near the level prevailing when the budget was framed – 77 points on the trade weighted index (TWI) and US103¢.

In framing the forecasts, there was another standard technical assumption that interest rates would move “broadly in line with market expectations at the time the forecasts were finalised”.

Markets have clearly moved on from when these technical assumptions were made, with the changes more supportive of growth than was assumed.

Reflecting the global funk unfolding since the budget, the Australian dollar is trading at about 73 on the TWI and is under US97¢, a fall of about 5 per cent. This lower exchange rate will help to cushion any negative impact on the economy from the global weakness and decline in commodity prices.

The technical assumption regarding interest rates has also been superseded by events, with the whole yield curve about 0.5 to 0.75 of a percentage point lower than at budget time. Like the exchange rate, this change in the interest rate outlook largely reflects the deterioration in the global economy.

If the current interest rate structure were factored into the budget forecasts, there would be some growth benefit to consumption, housing and business investment that would be some offset to the negativity prevailing from offshore.

From these issues alone, there is little hard evidence to suggest that the return to budget surplus in 2012-13 is any more or less likely than when the budget was framed in early May.

This does not mean that a surplus is guaranteed as global conditions may deteriorate further, assets prices may remain weak and the jobless rate may move above the level Treasury was forecasting.

If these trends do unfold, it would mean the budget surplus would be difficult to deliver. Having said that, it is worth noting that in these circumstances there would likely be further falls in the dollar and interest rates that would work to support economic growth, jobs and, with those, the budget bottom line.

For now, there is nothing to seriously suggest the Treasury forecasts will be wrong, or rather, in which direction any errors will be.

The surplus in 2012-13 is still more likely than not.

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RBA Views


The parlous state of the global economy, now showing up so disconcertingly in a commodity price free-fall, suggests that inflation pressures will be squarely to the down side over the forecast horizon.  As has been evident to most sensible observers for a while, there is a material risk that the RBA will miss it inflation target over the next year or two which means the economy will have under-shot its growth potential.

The RBA “fessed-up” to its misreading of the economy by cutting the cash rate by 50 basis points in May.  To see whether it has fully acknowledged the disinflation risks and global malaise will be revealed with its interest rate decision tomorrow.   Anything less than a 50 basis point cut will indicate that the RBA is still holding on, at least in part, to the mining boom, labour shortage view.  It if cuts 50 basis points, to 3.25%, it will be a recognition of the disinflation risks and will help to support growth and with that, help move inflation away from the undesirable sub-2% pace.  If it cuts less or not at all, there will be a jolt lower in confidence and with it, a downside bias to the inflation outlook,  Whatever it does, there is now a strong probability that the RBA will be cutting official interest rates to around 2.5% by the end of the year as it deals with the disinflation threat.

The market is pricing in a cash rate near 2.0%.  This implies not only a disinflation risk, but also particularly ugly news from the global economy.  While I am not optimistic, a 2.0% cash rate looks a little far fetched… for now at least.

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Monthly Inflation Signals More Downside to CPI


The TD-MI Monthly Inflation Gauge confirms that inflation is locked in at a low level and this will be a further valuable input into the decision on how much to cut interest rates when the RBA Board meets tomorrow.

With recent developments in markets, the global economy and in the domestic data, a 50 cut now looks a good call.  It actually looks a necessary policy change to make sure the economy does not fall further below trend.

The Inflation Gauge was unchanged in May after rising 0.3% in April for an annual rise of just 1.8% – inflation remains around or even a touch below the bottom of the RBA 2 to 3% target band.  The news in the monthly Inflation Gauge suggests an official CPI result of around 0.7% for the June quarter or around 0.6% for the underlying measure which, if realised, would see the annual increases at 1.4% for the headline CPI and 1.9% for the underlying inflation rate when those numbers are released in late July.

With inflation dead, buried and cremated, the concern for the economy now has several layers:

  • The world economy and global markets are ugly.  Growth is decelerating, commodity prices are diving and policy makers are hamstrung.  Not a great climate.  Many people pulling the policy levers globally don’t know what to do – or worse, can’t act due to political constraints.
  • In Australia, consumers are being hit with falling stock prices, falling house prices and only a few weeks ago saw interest rates move to a level vaguely accommodative.  Until then, the RBA had stubbornly kept interest rates too high.

But that is water under the bridge.  The RBA can get on the front foot and it should very directly cut interest rates by 50 basis points tomorrow to signal that it is doing what it can to make sure it doesn’t miss its inflation target on the down side.

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Not a Media Release From the RBA: 5 June 2012


Not a Media Release

Number 2012-XX
Date 5 June 2012
Embargo For Immediate Release

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

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 3.50 per cent, effective 6 June 2012. This decision is based on information received over the past month that suggest the risks to the global economic growth outlook have moved lower, along with the inflation outlook.

Growth in the world economy has remained subdued in the early part of 2012, and is likely to continue at a below-trend pace for the remainder of the year. While a deep economic downturn is not occurring at this stage, recent developments suggest that the tentative positive outlook for the global economy earlier in 2012 are reversing.

Growth in China has moderated and is likely to remain at a more measured and pace in the future. Conditions in other parts of Asia softened further in early 2012 and policy settings have generally been eased. Among the major countries, conditions in Europe remain very difficult with weak economic conditions are sharply rising unemployment.  Recent indicators suggest that growth in the United States remains subdued with growth at this stage remaining below trend. Commodity prices have weakened appreciably in the last month which indicates a slowing in global demand. Australia’s terms of trade similarly peaked about six months ago and are poised to fall further through 2012.

Financial market sentiment has deteriorated in the past month which has renewed pressure on wholesale funding costs for banks.  Market sentiment remains skittish and the tasks of putting European banks and sovereigns onto a sound footing for the longer term, and of improving Europe’s growth prospects, remain large. Hence Europe will remain a potential source of adverse shocks for some time yet which will weigh on global economic and market conditions.

In Australia, output growth was somewhat below trend over the past year, notwithstanding that growth in domestic demand ran at its fastest pace for four years.  Output growth was affected in part by temporary factors, but also what had until recently been the persistently high exchange rate.

Considerable structural change is also occurring in the economy. Labour market conditions appear mixed, with the recent data showing a more positive trend for employment and the rate of unemployment remains little changed at a low level.  Fiscal settings are expected to subtract for economic growth over the next year.

Inflation remains low and over the coming year, it is expected to remain around the bottom of the 2-3 per cent target range, abstracting from the effects of the carbon price.  If global conditions and commodity prices weaken further, inflation could move lower.

As a result of the reduction in the cash rate in May, interest rates for borrowers are a little below their medium-term averages which in time, will support borrowing and demand.

Credit growth remains modest overall. Housing prices are weakening as are the prices of stocks which is dampening consumer wealth.  Other indicators for housing are weak. The exchange rate has in the past month moved lower, particularly against a stronger United States dollar, partly matching the decline in commodity prices, the terms of trade and the global economy more generally.

The outlook for inflation is such that the Board has scope to further adjust monetary policy settings if recent downside risks to the economy intensify or come to fruition.  The Board will continue to closely monitor economic trends and will set interest rates at a level that is supportive of growth and employment and at the same time, maintain the inflation target over the medium term.


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