Australia | Nov 01 2012
– Strong CPI casts doubt over a November rate cut
– Economy still needs stimulus, in many a view
By Eva Brocklehurst
The Reserve Bank board steps up to the plate again next week for its Melbourne Cup Day meeting. The monthly meeting always falls on Cup Day in November, the first Tuesday. It chimes with all the racing terminology mustered to predict just what the board is thinking, and then to dissect the announcement at 2:30pm on that day.
The Reserve Bank has eased interest rates by 125 basis points since it commenced the current rate cutting cycle last November including, after a brief pause, a cut in October to take the cash rate to 3.25 per cent. It cited a soft global economy, lower commodity prices and low inflation for that decision. After that, a jump in September quarter inflation was the start of many reining in their expectations of a follow-up cut. Some have now moved the expected decision out to December, the RBA's last meeting before a two month hiatus over the summer. However, others have reiterated their views that November is still ripe for a cut..
RBS Australia expects another 25 basis point cut next week but then expects a pause, with a further rate cut likely in the March quarter next year. The economists' current expectation is for a low point of 2.75% in the current cycle and rates to turn higher in the second half of 2013. They don't believe the Q3 inflation data, despite surprising on the upside, was an obstacle to a cut. Headline inflation did jump in the September quarter, up 1.4% on the Consumer Price Index, while underlying inflation was in line with expectations. RBS economists expect the RBA should look through any one-off rises related to the introduction of the carbon price. The underlying rate of inflation in Q3 is around 2.5%, right in the middle of the RBA's target band.
For our major trading partner China, the most recent round of GDP and industrial production data suggests that the slowdown is bottoming out, but there are no signs yet of a cyclical upswing, according to RBS. They suggest a significant cyclical recovery seems unlikely unless the authorities materially ease monetary and fiscal policy further on that front. Interest rates remain at historical lows in both Europe and the US. Furthermore, interest-rate sensitive sectors of the domestic economy have responded only modestly to the RBA's easing so far. Consumer confidence is still weak and retail trade is struggling. RBS says the RBA wants to see other parts of the economy growing before mining investment peaks around the middle of next year.
Meanwhile, the latest labour force figures from the Australian Bureau of Statistics, an important indicator of economic health, showed a jump in the unemployment rate to 5.4% from 5.1%. The resilient Australian dollar quickly rebounded back to pre-October board meeting levels following the interest rate cut in that month, taking RBS by surprise as they expected it would be closer to parity with the US dollar by now and under downward pressure. Anecdotally, the economists maintain, central bank interest in Australia's dollar seemed to increase shortly after the October rate cut and this flow doesn't seem to be softening, despite Australia's narrowing interest rate differential with the rest of the world. Indeed, the currency looks like it will provide no help to the RBA as it attempts to ease overall financial conditions.
UBS sees a November rate cut as necessary but a closer call after the Q3 CPI. The economists believe October's rate cut came after some positive events offshore, such as the US Fed's quantitative easing mark 3 and the German constitutional court's ruling on bail-out funding. However, in their view the RBA saw a need to respond quickly to lower commodity prices and a subsequent drop in national income down the track. They expect a further cut in rates in November will keep the central bank on the front foot in this respect. However, they expect the cash rate will trough at 3%, after the next cut, as they believe the RBA will resist pressure to push the rate below 3% until it sees more CPI evidence that inflation is contained. The only factor which would cause the central bank to go on the offensive, according to UBS, is rapidly rising unemployment and so a further modest cut certainly increases the likelihood of avoiding this without much risk.
Westpac economists thinks that the Reserve Bank has a broad plan – to provide support to the non mining sectors of the economy by easing financial conditions in light of the likely downturn in mining activity from 2014. Noting the tightening of federal fiscal policy at the Mid Year Economic and Fiscal Outlook (MYEFO), the economists see it stressing the need for policy easing from the Reserve Bank. So, will the Q3 CPI constrain the Reserve Bank from delivering another cut on Nov 6? Westpac thinks it won't. The economists note that a 'neutral' cash rate is estimated to be around 3.9%. A cut to 3% would still only see the cash rate around 90bps below neutral. Westpac concludes that the current contractionary stance of fiscal policy, and rigidities in the Australian dollar in the face of falls in the terms of trade, provide strong arguments to support a further easing, despite the 'mild surprise' from the September quarter CPI.
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