Tuesday, 10 April 2012

More Poor Data - A Pragmatic RBA Will Cut 50 in May

Consumer sentiment fell 1.6% to 94.5 points in April – a level around 10% down on the average of the past decade.  Mining boom or not, consumers are gloomy and when that is the case, they usually scale back their spending and overall economic growth will be subdued.

At the same time, the number of housing loan approvals fell 2.5% in February after falling 1.1% in January confirming an on-going under-performance of the housing sector.  In concert with the seasonally weak house price data, there is no doubt that housing in all of its guises of finance, prices and certainly new construction, is weak.

With global markets now starting to again question the financial viability of the governments of Spain and Italy, the risks for the Australian economy from global events are huge and almost uniformly to the down side.  Commodity prices are falling , US and German bond yields are falling back to fresh all time lows and recent US data suggest that some of the strength in the US around January was simply the result of a warm winter.

As the RBA undertakes some self-assessment of its recent record, it would acknowledge that it has misread the economy.  The decision not to cut at any of the first 3 RBA Board meetings of 2012 was based on a notion of improving credit markets (no longer the case);  trend GDP growth (disproved with the December quarter national accounts); the low unemployment rate (which ignores the drop in employment and participation); and concerns that wages and inflation are threatening to the high side (we’ll see, but a gutsy call given all of the other news).

So what should the RBA do now?

The May RBA Board meeting will mull over a 25 or 50 basis point rate cut.  A cut of 25 basis points would be only a baby step to support growth and keep inflation in the groove when a giant leap is needed.  It seems that whatever the RBA does, the banks will keep some of the move to maintain profitability.  If the RBA cuts only 25 and say 10 or 15 basis points are passed onto to borrowers, the net move in retail interest rates since December would be zero – despite the undoubted and material deterioration in the economy and market conditions. 

This is not good enough.

This means that a pragmatic and realistic RBA Board would cut by 50 basis points.  The RBA with Glenn Stevens as Governor has shown it will act on monetary policy without fear, self-doubt or favour and pragmatically act when economic and market circumstances change.  It hiked interest rates during the 2007 election campaign, it slashed rates 100 basis points at the outset of the GFC when the market was torn between it going 25 or 50. 

The RBA always gets it right – eventually.  It can play catch up with the stroke of a pen writing 50 instead of 25.

Which leads me to think that this time, at the 1 May Board meeting, it will cut by 50 basis points to move retail rates to a slightly accommodative stance.  Going 25 is too small given the poor economic data and the downside risks ahead.

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