Tuesday, 31 January 2012

Mirabella Misunderstands Manufacturing

Shadow Industry Minister, Sophie Mirabella, has come out and bagged the Government for its policies on manufacturing.

According to Ms Mirabella:

“If Ms Gillard had a genuine interest in the car industry, in manufacturing or in innovation, then she would never have:

  • broken her promise not to introduce a carbon tax – a $460 million burden on the industry; 
  • broken $1.4 billion of car industry promises;

  • dumped manufacturing from Cabinet; 

  • crippled government support for business research and development; or

  • shown complete ineptitude in failing to stem the worst rate of manufacturing job losses in Australia’s history. “

With those comments in mind, it is interesting to have a look at how manufacturing has performed over the past 35 or so years under each side of politics:

Let’s start with the Fraser years from 1975 to 1983. In those 7 years, manufacturing output fell at an average annual rate of 0.1%. As a share of GDP, manufacturing crashed from 16.0% to 13.3%, an average loss of 0.4 percentage points of GDP per annum over 7 years.

Under the 13 years of the Hawke and Keating Government’s from 1983 to 1996, manufacturing output grew at an annual average rate of 2.7%. Not too bad, but it still fell as a share of GDP to 11.5%. that’s an average loss of just over 0.1 percentage point of GDP per annum over those 13 years.

In the 11 ½ years of the Howard government to 2007, manufacturing grew at an average annual rate of 1.5%, roughly half that recorded by manufacturing under the Hawke and Keating years. As a share of GDP, manufacturing slumped to 9.0% of GDP, losing 0.2 percentage points of GDP on average per annum under Howard.

With the Rudd and Gillard Governments since the end of 2007, manufacturing output has fallen at an annual rate of 0.3% - and as a share of GDP is has dropped to just 8.2%. That’s an average loss per annum of around 0.2 percentage points. This is effectively the same relative performance as was achieved over a longer time frame of the Howard government, a vastly superior to the record of the Fraser Government, but lagging well behind the quite impressive results under the Hawke and Keating Governments.

And guess what?

The best performing years were when tariffs, protection and largesse were slashed. A bit of tough love goes a long way.

But whatever the policy shortcomings relating to manufacturing right now, Ms Mirabella is barking up the wrong tree.

House Prices Down

The ABS measure of house prices confirmed a 1.0% fall in the December quarter, making it four straight quarterly declines.  According to the ABS, house prices peaked in the June quarter 2010 and since then have fallen 5.5%.  In real terms, this is a fall approaching 10%.

The data fit broadly with the RPData series which has the advantage of being very timely, but the disadvantage of being choppy from month to month (much like the monthly inflation data versus the quarter consumer price index).

Either way, there is no doubt that the housing market is weak.  With consumer sentiment also weak (could be some auto-correlation in that link) and mortgage rates still some way from being "easy", house prices are likely to remain in the doldrums a little longer or at least until more interest rate cuts come through.
The critical point in all of this is that house prices are unlikely to fall too much more - maybe another 5% or so - at most.  This is because of the massive bias towards floating rate mortgages and the common sense from the RBA in moving rates to an accommodative stance.  House prices are likely to bottom out during 2012 at which time new construction activity should also be on the rise.

Monetary Policy & Next Week's Rate Cut

Monetary policy isn't all that hard or complex most of the time.  Basically it's a decision on whether to keep rates steady, put them up or put them down.  For decisions to change rates, the question is by how much?

If there is a misreading and a policy mis-step from the RBA, they are in luxurious position where a quick correction can be made without fear or favour.

As the final drafting of the Board papers concludes about now, I suspect the recommendation will be for the Board to agree to a 25 basis points cut in the cash rate to 4.0%. 

The nuance of that cut is open to debate – of course – by the fiercely independent RBA Board.   There is some non-trivial possibility that some of the Board members will argue for a 50 basis point cut on the basis of the news since the December meeting, especially the sub-trend growth performance that has seen inflation fall sharply and employment drop.  The well-covered need for the banks to counter the higher cost of funds supports this argument.  There will also be a bit more information for the RBA to digest between the sign-off of the Board papers and the meeting next Tuesday, but this is more likely to support their action, rather than change it. 

If the RBA goes on to cut 25 basis points and it finds this isn’t enough, the door is always open for the meetings in March, April, May and into the future to cut again as needed.  From a monetary policy perspective, the difference between a 50 cut now and two 25 cuts four weeks apart is zero, other than perhaps through confidence channels and regular “good news” rather than a crunch lower in rates in one big hit.

The key issue for the RBA is that since the December interest rate cut, there has been a surprising and disconcerting deterioration in the labour market with employment falling for two straight months.  This rarely happens outside a recession.  Also, the CPI confirmed a marked deceleration in inflation over the second half of 2011 and it seems that inflation is fly-papered to the middle to lower half of the RBA target range.

Global conditions are at least as worrying as in December, even though bond yields have plummeted to levels consistent with on-going recession.  Housing remains in a funk with prices soft and new construction weak.  Business and consumer confidence are on the soft side too.

And what’s more, there is a confirmation that fiscal policy will continue to run along in a contractionary mode, a key factor reinforced by the Prime Minister, Ms Gillard.  The RBA can rest assured that its policy actions will not be thrown off course by misguided fiscal settings.  In other words, it can cut in the knowledge that fiscal policy will not add stimulus and circumvent the RBA's actions.

All up, a rate cut is all but a done deal.  

Australian House Prices - Down, down, prices are down?

The RPData monthly house prices have had the following profile month on month % change:

  • Down
  • Down
  • Down
  • Down
  • Down
  • Down
  • Down
  • Down
  • Down
  • Down
  • Up 
  • Down
Yet we see headlines like this:

"House prices may have bottomed"


Monday, 30 January 2012

Housing credit dives to 34 year low: House prices down again


House prices fell 0.2% in December, after rising a revised 0.4% in November.  House prices are around 3 ½% down over the past year to lock in one of the weakest annual house price results seen in Australia.

To be sure, the house price falls are a million miles from the weakness seen in Ireland, the US, UK, Spain and many other countries, but the lack of evidence of a turning point is a little disconcerting.

There are no hints yet that house prices are forming a base, although the seasonal break in housing turnover in December and January needs to be considered when looking at monthly data.  It might be, it might not be - let's see the results for February and March for a better guide.  That considered, the broad trend though 2011 was steady and increasingly uncomfortable falls in house prices.  No wonder the banks are keen to have some relief via RBA rate cuts as they hope like crazy to avoid a more serious housing issue.

No wonder consumer sentiment is in the gutter.

In other data, total private sector grew by a weak 0.4% in December to be 3.5% above the level of a year earlier.   This locks in the deleveraging occurring with credit growth remaining well below nominal GDP growth. 

Consistent with the soggy house price data, housing credit growth slowed to just 5.4% in the year to December, the weakest result ever recorded in the 34 years of available data.  Personal credit actually fell again in December, a sure sign consumers are spending less, saving more in these uncertain times.  This caution probably accounts for the fall in employment in recent months.

The housing sector, through the credit and house price data, is starting to become a stone in the shoe for the economy.

The NAB business survey showed conditions and confidence a tick higher in December, which is good news.  The level of business sentiment and conditions are now broadly consistent with the economy growing around 3%.  Sentiment needs to remain positive to maintain the current level if economic growth of that order is registered in 2012 and beyond.

All of this information is feeding into the final drafting of the RBA Board papers and critically, what recommendation will be taken into that meeting. 

These data only reinforce the safe forecast that the RBA will cut 25 basis points and maintain an open view on future rate cuts.  The door is open, however slightly, for the RBA giving consideration to a 50 basis point cut to support growth in the latter part of 2012 and into 2013.  There are still a few days of data and events to come, to cement the case for either a 25 or 50 cut.

Supermarket food discounting to bias inflation lower

There is a simple macroeconomic effect of the food price discounting from the big supermarkets - inflation will be lower.  See the story here  http://tiny.cc/ia2e5

If the discounting or bias to lower price increases is a structural change reflecting productivity or the onset of healthy competition, interest rates will also be biased a bit lower.

What is also important is that the purchasing power of consumers will be higher.  Cost of living pressures will subside.  In a period where Australia has seen a decade straight of real wage increases, massive income tax cuts and pension rises, consumers are doing very well thank you - a trend that is only going to be enhanced with lower food prices and a bias to lower interest rates.

I can't see what's wrong with it other than for the few price gougers who are being found out by the supermarkets. 

Sunday, 29 January 2012

Interest Rate Betting - A February cut is long odds on

The 7 February Board meeting is shaping up to be a doozie.  There are more than the usual arguments for the RBA deciding to keep the cash rate steady, for cutting 25 basis points and even cutting 50.

These will not be canvassed here, but the current OIS market is pricing in about a 90% chance of a 25 basis point cut.  Or is that a 10% chance of no change or a 45% chance of a 50bp cut?


The bookies are allowed to offer fixed price odds on changes in official interest rates and this is what they currently are pricing for the February RBA Board meeting:

No Change
25bp cut
50bp cut
50 bp cut or more
75 bp cut  

Something for everyone - I have left off the odds for a rate hike.

While this is NOT a recommendation, it is clear from the above odds that the TAB is offering the most generous returns for those in the rate cutting camp.

$11.00 for a 50 cut or more would be a good bet if the RBA is viewing the current global Lesser Depression, the local jobs and inflation data and the current stance of fiscal policy as drivers of the need to get the cash rate to a mildly accommodative stance.  This is further enhanced by the jump in bank funding costs.  A one in ten chance of a 50 cut in these circumstances?  Sure.

For a likely 25 basis point cut, the $1.33 on offer sees a 33% tax free return, if the RBA choses that option.  The odds look short, but for any with a strong conviction on that move, it’s not a bad return and would suggest a more steady approach from the RBA and of course, they meet 4 weeks later and can go another 25 then as required.

For those thinking the RBA may be on hold, for whatever convoluted reasons, the $4.00 on offer from Sportsbet would seem too good to be true.  A 300% tax free return if the RBA choses to hold the line... thanks!

These odds will change with data and events between now and next week.  Let's see how they end up, but in the last few months, the big shorteners (25 cut) have taken the prize.  The money has been spot on.

Friday, 27 January 2012

Terry McCrann's Glowing Endorsement of the Gillard Government

In an interesting twist on the monetary policy debate, News Limited's Terry McCrann is heaping praise on the economic policy management of the Gillard Government saying that “he is happy with the mix” with tight fiscal policy and easier monetary policy.

Indeed, as has been obvious for some time, the current monetary policy easing cycle owes much to the fiscal settings of the Government including the cuts in spending and the massive turnaround (4.3% of GDP) in the Budget balance.

McCrann acknowledges (almost a year after the event), that fiscal policy is playing a vital role in allowing the RBA to move monetary policy to an accommodative stance.  See McCrann here – http://tiny.cc/05p2w

McCrann outlines something that is well understood within the Government:  there is a trade-off between fiscal and monetary policy.  He notes:

  • “The past few years have shown precisely why discretionary monetary policy is so much to be preferred to fiscal for economic management, exactly because of its flexibility.”
Yes – spot on Terry.  Fiscal policy is best set for medium term objectives (small surpluses over the cycle) and used only in emergencies to rescue the economy from events like the current Lesser Depression. 

The current mix of economic policy settings are near perfect.  Look at the Australian dollar if you want confirmation of the assessment of global investors.   As McCrann touches on, picking up the issue I have written about before, monetary policy can be changed quickly, reversed if needed, moved from super easy to super tight in next to no time.

It’s set by the independent RBA Board without fear or favour.

And the “killer” fact – IT”S FREE!

A budget decision to boost spending on project XYZ is obviously going to have an impact on the budget and public finances.  It can and is difficult to unwind.  The warning label on fiscal stimulus should be “use only in emergencies”.

McCrann notes:
  • "Once the budget has been sent deep into deficit it is extraordinarily difficult to bring it back even to balance. It required a tough commitment running some years into the future,"

Spot on Terry.  But it is being done right now with the most dramatic turn in the Budget balance ever recorded.  A tick for the Government.

An interest rate cut, as discussed, has no direct impact on the budget or public finances, but it does help to deal with the business cycle, boosts borrowing and economic activity… and reverses these in the event the economy overheats.

McCrann’s final point,
  • "absent another global meltdown, fiscal policy is effectively locked into tightening. The government remains committed to cutting this year's expected $40 billion-odd deficit to balance next year."

  • "I'm more than happy that this is the mix. That Gillard and Swan have fiscally handcuffed themselves and the cabinet, and that it will be all down to the judgment and nimbleness of RBA governor Glenn Stevens, the bank's management and the board."

It is good to see this discussion starting to permeate the economic policy debate.  It helps explain why the RBA is going to cut interest rates which is something that people who fail to look at the budget never quite understand and certainly missed late last year when they were screaming about an inflation blowout and the need for many more interest rate hikes just weeks before the RBA starting interest rates.

Fiscal policy matters and right now, the Government is committed to keep it as tight as a drum.

Thursday, 26 January 2012

February - Bash-A-Bank Month

Whatever the RBA does with the official cash rate after its 7 February Board meeting, February is shaping up to be "Bash-A-Bank" month.

The scenarios are simple.

If the RBA for some bizarre reason decides not to cut the cash rate, most of the banks will hike their variable mortgage interest rates by something like 10 to 15 basis points around the middle of the month.  Just think of the atmospherics when such a rise is announced.  Swan, Hockey and the drovers dog will line up to smash the banks for their "greedy rip-offs of hard working Australian home owners" or similar gumph.  It would, however, create a problem for the economy as it crimps cash flows at a time when the economy is soft and the labour market is weakening.  Paradoxically, it is actually why the RBA will not hold rates steady.

If the RBA cuts the cash rate by 25 basis points to 4.0%, it is likely that the banks will pass on 10 to 15 basis points for borrowers and pocket the other 10 to 15 for themselves.  The bank bashing would not be quite as acute (some has been passed on after all) but nonetheless, the bank PR people should be anticipating a flogging.  Economically, a split pass on the rate cut is probably what the RBA wants - a little relief for borrowers and a bit of costless support for the banks.

Of course, the RBA could cut 50 basis points, which strategically could be a good move.  It would go 50 if it has more significant concerns about the domestic growth and labour market outlook and worries about bank funding costs.  If the RBA goes 50, there is greater scope for the banks to pocket 20 or even 25 basis points and pass on 25 or 30.  Banks would be delighted with such a move.  Borrowers would also be happy.  That is arguably the best result for all - costless help for banks AND borrowers.  The criticisms of the banks in this instance would be less direct if the RBA were to articulate the background to its action.

Whatever the result, the groundwork is in place to hit the banks as the margin between the cash rate and mortgage rate (not net interest margin by the way) is set to rise.

Wednesday, 25 January 2012

The US Federal Reserve Sends a Message

The US economy was so hopelessly weak, wealth destruction was so widespread and job losses so acute that the Fed cut official interest rates to zero. 

That was back in December 2008, more than 3 years ago.

Since then, the economy has been so dreadfully moribund, its banks effectively insolvent, job creation so sluggish, that the Federal Reserve has kept the exceptionally low (zero %) interest rate settings in place. 

Sure, there have been some less bad data in recent times, but the economy is performing like a gambler making $2 a spin, having lost $1 million in the last three years.  An improvement; yes – but healthy?  A resounding no.  There's a long way to go and many risks before anyone, including the Fed, can be sure the losses of the Crisis have been recouped.

This morning, Canberra time, the Federal Reserve released a statement where it said that it plans to keep interest rates near zero until the end of 2014. This adds 18 months to its previous plans and reflects its fear about the outlook.  The problems confronting the economy, employers, home owners and the administration as it tackles a sky-rocketing sovereign debt crisis are huge.  Zero interest rates are needed to turn these negatives around.

There can only be one conclusion from the latest Fed statement and that is the US economy will remain mired in a deep funk for many years.

The RBA would be wise to take this news into account as it drafts the Board Papers for the 7 February Board meeting.  With local inflation well under control, jobs being shed at a disconcerting rate and GDP growth muddling along, an interest rate cut is the only logical conclusion.   

Tuesday, 24 January 2012

Inflation is a Dead Duck

The CPI recorded zero change in the December quarter locking in a marked deceleration in inflation through the course of 2011.  In the last six months, headline inflation has run at an annualized pace of 1.3%, with some of the deceleration due to a reversal of the price spikes for goods and services impacted by the floods and cyclones early in 2011.

The RBA measures of underlying inflation (which strip away some of the price impact from adverse weather) rose 0.6% in the December quarter after rising 0.4% in the September quarter to be 2.6% above the level of a year earlier.  This continues the run of inflation results at the mid-point of the RBA target.  The RBA has delivered underlying inflation at 2 ½% for the last 18 months.

Well done team!

But in the last two quarters, the underlying inflation rate has increased at an annual pace of just 1.9% - below the bottom of the RBA target and the lowest six month reading (as far as I can calculate with available spreadsheets) since 1998 and is equal to the second lowest six month result since the early 1980s (which is as far back as the history of the underlying inflation measure goes).  I am checking this and will amend if revisions have changed this calculation.

On this measure, inflation is a dead duck.

Thankfully interest rate cuts have started with this disinflationary pressure and with this result, more will be delivered.

With the economy muddling along for the last 3 years, with never once in that time GDP growth rising above 3.0%, it should be no surprise that inflation is so low.  There’s growing capacity in the economy.  What’s more, the labour market is shedding jobs, asset prices are falling with houses and stock prices lower; fiscal policy is tight and the global outlook is shaky. 

The inflation results suggest the RBA is all but certain to deliver an interest rate cut at its 7 February Board meeting with the event and data flow between now and then determining whether the current thinking of a 25 basis point cut will need to be super-sized to a 50 point move.

Global economic conditions may tilt discussion towards a 50 point move, as will the bank funding cost pressures starting to hit the banking sector.  The mining boom, the still high terms of trade and business investment explosion suggest the RBA should cut 25 points only.

The local news between now and the RBA Board meeting on house prices, monthly inflation, retail sales and building approvals will all figure in the discussion.  At the moment, the odds favour a 25 point cut, but stay tuned.

The IMF and the RBA

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. 

Monday, 23 January 2012

Good money chasing bad

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.

Peter Costello Needs to Read the Budget Papers

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.


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.