Australia | Jul 15 2008
By Greg Peel
“In assessing this recommendation [to leaves rates unchanged], members concurred that the evidence becoming available in the latest month had added weight to the view that the current stance of policy, in conjunction with the more general tightening in financial conditions that had occurred since the middle of last year and most recently the additional rise in fuel costs, were working to restrain demand. Consumer spending had slowed significantly and there had been a marked decline in the growth of credit to both households and businesses. Surveys indicated that confidence had fallen further over the past month and asset prices were weakening. In addition, there were some early signs of softening in labour market conditions. The deterioration in conditions in financial markets over the past month had probably tightened financial conditions a little further.”
Take this statement alone, lifted from the minutes RBA’s July monetary policy meeting held a couple of weeks ago, and one would conclude there was little possibility of another rate hike occurring anytime soon.
The board notes in the meeting that Australian GDP rose by 0.6% in the March quarter to a yearly 3.6%, but even this figure seemed to be distorted by paradoxically high contributions from output growth in the insurance & finance sector. Take this out, and yearly growth would be only 3.2%. Real disposable household income growth had been flat for six months, and rising fuel costs were contributing to a slowing of incomes. Furthermore, lower superannuation returns were also having an effect. Housing activity remained soft, and a shift down in house prices was a significant change from 2007. Business loan approvals had fallen sharply, both due to a decline in demand from businesses and tighter credit conditions being imposed by banks.
The ramifications of the Varanus gas fire would ultimately knock about 0.25% from GDP growth, the board decided.
The board also decided there was no “material” change in the inflation outlook, and that the second quarter CPI would probably come in at 1.0%. If the oil price remained at current levels [it has], this would contribute 0.25% to inflation.
Put all this together, and one would assume even a high CPI result may not sway the RBA into believing another rate hike was particularly necessary, given demand in the economy seems to have been behaving just the way the RBA had hoped, or indeed had slowed even quicker than the board might have hoped. But there have been a few developments since the meeting.
Firstly, the board had noted that retail sales growth had fallen, and would likely continue to do so. It hasn’t however – the June retail sales data blew everyone out of the water. The board also made note of the first weak set of employment numbers in a long time in May, and suggested the trend would continue. However, employment bounced back in June.
Nevertheless, while these developments only serve to confuse the picture, the RBA also noted there had been a few “renewed credit concerns” in global markets in June. We now know this is an unfortunate understatement. World financial markets are once again in turmoil as the US stares down the abyss. And while the RBA noted that funding costs had stabilised for the local banks, we have since had all but one major bank independently raise borrowing rates.
Development One would be enough for the RBA to consider that another rate rise might be overly damaging to borrowers under renewed credit market fears, but Development Two is a proxy rate rise anyway. The RBA need not raise even if it was unsure, for the banks have already done so.
There only remains the niggling problem of inflation. The board recognised their global counterparts had begun to move into a more hawkish, inflation-fighting mode, although in the case of the US the board also recognised those renewed credit market problems. Well now that we’ve had the Fannie Mae, Freddie Mac and IndyMac debacles, it has again become far more likely that the next Fed rate move will be down again, not up.
So the RBA needn’t particularly feel it’s being left out if it doesn’t raise rates. Nevertheless, while the oil price doesn’t seem to bother the board – the board sees it as much as a dampener on spending as a contributor to CPI – there continues to be concern amongst members of the blow-out in commodity prices and the effects on the terms of trade, and of the possibility of increased wage claims.
In the case of the former, the problem of improved export over import prices feeding through to increased spending remains. As does the small problem of the tax cuts that are about to impact on consumers. In the case of the latter, this is a very real threat. Unions appear to now be lining up for pay rises in order to help cope with the high cost of petrol. And they will likely stop at nothing, given the evidence of the transport union’s holding the NSW state government to ransom over Pope Day.
This is pure 1970s stuff. The current financial market problems are more 1930s. Are we in one, the other or both at the moment or, even more ominously, have we never been here before?
Whichever the case, a rate rise does not look like the best medicine at present, at least for now. Initial economist reactions tend to be in agreement – we remain On Hold.