Wednesday, 18 January 2012

Since the December RBA Board meeting ...

In the six weeks since the last RBA Board meeting, where it surprised a lot of people with another 25 basis point interest rate cut, quite a lot has happened.  The offshore news has been mixed – a slowdown has been confirmed in China, while the US has had better economic news, probably based on unseasonally warm winter.  Europe remains in the dumps, as are the UK, Canada and Japan.  Commodity prices have been a touch weaker.  This is probably as the RBA thought.

Locally, the news has been generally on the soft side.  Bank funding costs have not eased and have probably been squeezed higher.  What’s more, the Australian dollar is about 5% higher despite what has been neutral-to-bearish currency news. 

The RBA needs to cut interest rates at its 7 February meeting with a 50 basis point cut a non-trivial probability.  The December quarter CPI next week will be critical to the size of the cut.

In terms of a couple of issues dear to the RBA’s heart - when announcing the rate cut in December, RBA Governor Glenn Stevens noted in relation to the weaker parts of the economy:
  •  “changed behaviour by households and the high exchange rate have had a noticeable dampening effect.”

As mentioned, the Australian dollar is about 5% higher since then, consumer sentiment is markedly weaker and retail sales recorded no growth.  Hardly upbeat news when the RBA comes to consider these parts of the economy.

Mr Stevens also noted in December:
  • “with labour market conditions now softer, the likelihood of a significant acceleration in labour costs outside the resources and related sectors in the near term has lessened.”

Since then, 36,900 jobs have been shed, despite a 42,100 rise in the working age population.  What's more, the participation rate has dropped 0.3 percentage points and aggregate work hours have fallen.

In other news, housing finance has ticked up, building approvals remain in the doldrums and house prices weak with a miniscule 0.1% rise in November after a year of straight decline.

And all of this with monetary policy only neutral and fiscal policy as tight as a python’s squeeze.

The February RBA Board meeting should be a doozie.  If, as seems likely, the December quarter CPI is low, probably negative, there will be a few Board members arguing for a 50 basis point cut.  They might prevail.  Such a view will only be reinforced by the rise in bank funding costs with there being no doubt that banks are under pressure to hike their retail rates.  As discussed before, the beauty of a 50 basis point cut it that there can be 20 or so basis points for the banks and 30 or so for consumers and business.  Everyone’s a winner in this scenario including the unemployed.

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