I got a bit lucky on the RBA today. I was right – they held steady at 4.25% – but the truth is I had my reasons wrong.
Experience has taught me that the unemployment rate is the best indicator of the economy’s state, and as it had been steady at ~5.25% for three quarters, I judged that the RBA would continue to assess demand as around trend.
Thus, I concluded, the RBA would hold steady – for they lacked evidence that there had been a material weakening of demand. The last line of the Bank’s statement said otherwise – the demand test had been met:
The Board’s view was also that, were demand conditions to weaken materially, the inflation outlook would provide scope for easier monetary policy. At today’s meeting, the Board judged the pace of output growth to be somewhat lower than earlier estimated, but also thought it prudent to see forthcoming key data on prices to reassess its outlook for inflation, before considering a further step to ease monetary policy
So – clearly the RBA is waiting for Q1 CPI on 26 April. You might argue that unemployment is also a key bit of price data (that’s sure how i think of it), so my mental model isn’t totally wrong … but for sure, I’ll be paying more respect to GDP from now onward.
My point forecast for Q1 Core CPI is a little below 0.6%q/q, and I think that will be low enough for an easing. My guess is that the Government will leak like crazy about how tight the budget is going to be, and then try and pin their star on a May cut.
They are probably hoping for May+June – which will take an increase in unemployment, as well as a tight budget and contained inflation.
As I blogged earlier, the RBA has an inclination to cut official interest rates in May provided the next inflation print is propitious.
This leads to the obvious question, what is the threshold print that would yield a cut in official interest rates. As I was driving home, I was listening to a commentator who opined that a quarterly print of 0.6 or lower would be necessary.
When I look at the data, I think there is little more room than that. If you look at the last four quarters of the average of the trimmed mean and weighted median, the first two were a print of 0.8 per cent. The third was a print of 0.4. The last quarter was a print of 0.55.
In rough terms, a quarterly print of 0.8 for the first quarter of 2012 would leave the annual rate largely unchanged at around 2.6 per cent (because the lapsing quarter would be the same as the new quarter). For this reason, I suspect the threshold is a quarterly print of 0.8 or lower, even though a print of 0.8 per cent represents an annualised rate of 3.2 per cent, which is above the target band.
I suspect a quarterly print of 0.9 (that is to say, 3.6 per cent annualised) would be a bridge too far for the RBA. Although it would only see the annual print increase by 0.1 percentage points, it would suggest an inflation problem may be lurking in the pipeline.
If the dollar remains where it is now I think they will cut for sure by .25 . The big problem is our dollar has become very unstable over the last week or two making it anybodies guess.
If the dollar remains where it is now I think they will cut for sure by .25 . The big problem is our dollar has become very unstable over the last week or two making it anybodies guess.
Yep - the problem is that there are arguments both for and against, and whatever they do will have some negative consequences.
I still think they'll keep rates where they are for as long as they possibly can.
Why bother to advertise a rate cut in a month's time instead of doing it now?
Well, it might be to give the bank's hawks a few more weeks to find evidence of the capex boom feeding through, but it also is a way of building expectations about the direction of monetary policy.
Effectively, the RBA gets to announce an interest rate cut twice.
A 25 basis-point trimming in the bank's cash rate actually doesn't do much by itself to stimulate consumer spending.
The vast majority of people with mortgages simply pay down their loans faster, not reduce their repayments to give Solly Lew a lift.
For all those people who spend the money they receive for lending to banks, there's actually a reduction in income. Any reduction in overdraft costs for businesses is nice, but for those considering taking out a loan, most are smart enough now to prudently budget for higher rates than they'll pay – or at least one might hope they are.
As for the revival of the housing industry, productivity issues, especially evil local, state and federal government policies, have much more to do with our under-building than 25 basis-points off a mortgage.
The RBA has been clear for many months now that rates weren't about to rise in the foreseeable future. Now it's building an expectation of rates falling - it's more about consumer psychology than actual dollars.
I'd like to see the bulls squeal like the pigs they are if the RBA lowered and the banks didn't. That will be very entertaining and a day for some glorious schadenfraude.
But I don't think the RBA will lower, why should they? House prices have barely come off and lowering .25 percent will probably barely do a thing and may very well add fuel to the ponzi. There's enough idiots in the ponzi as it is and surely some of the RBA members have a conscience and can see right through our oligarchs and retail morons.
stinkbug omosessuale Frank Castle is a liar and a criminal. He will often deliberately take people out of context and use straw man arguments. Frank finally and unintentionally gives it up and admits he got where he is, primarily via dumb luck! See here Property will be 50-70% off by 2016.
The usual coalition of real estate spruikers and inflation doves were out bemoaning the Reserve Bank's decision to keep interest rates on hold this week.
There may indeed be room for a little easing. Things are slow here. And the slowing economy of China, mirrored by lacklustre economic releases at home, must have lent the RBA governor, Glenn Stevens, and his board pause for thought.
Inflation, however, is the central bank's main game.
Things have been deflationary for so long that people underestimate the drastic risk of runaway prices.
Make no mistake. Inflation is coming back. Timing is the only question.
The US Federal Reserve chairman, Ben Bernanke, was out feeding the market chooks this week with his "FOMC" (Federal Open Market Committee) report. The real Fed minutes of the meeting won't be released until 2018 - they must be full of fear and loathing - but the usual meticulously manicured precis spoke of cautious optimism, what else?
The US economy was recovering - albeit at snail's pace - so there was no need for QE3, the chairman said. What? No QE? Surely the Fed's raison d'etre is to prop up markets. They must be "kicking the can down the road"!
The markets were "disappointed", the headlines were "disappointed". "QE coming in June," Goldman Sachs said, just as "disappointed" as the next Wall Street muppeteer.
As Wall Street sulked, global sharemarkets had their worst week in three months.
Most people wouldn't have a clue what QE is. It sounds like an ocean liner. It stands for quantitative easing. And the European version is the even more recondite LTRO (long term refinancing operation).
But it is these two programs - both of which involve printing money on a grand scale - that may quite possibly have a devastating influence on their lives.
Sadly, QE has been used to prop up Wall Street, addicted to free money as it is. Though its effect in rebooting the listless US economy, the purpose for which it was purportedly designed, has been marginal.
Nonetheless, together the Fed and the European Central Bank have printed $US6 trillion. As if that weren't stimulus enough, interest rates in Europe, the US, Britain and Japan remain close to zero.
WE cheer him on when he cuts interest rates, and get angry when he leaves them on hold, but most Aussies don't even know his name.
Reserve Bank of Australia governor Glenn Stevens will be the toast of the nation if interest rates are cut next month - at least among borrowers.
But an opinion poll this week found that only one in 10 respondents could correctly name the RBA governor.
Given the amount of flack the governor gets as the nation's most influential public servant on interest rates, it's a staggering result.
Still, 83 per cent of those who did know his name thought Stevens was doing a good job.
That figure may get a boost, especially from borrowers, if, as seems increasingly likely, the central bank cuts the cash rate at its next board meeting on May 1.
Mr Stevens was unusually candid in his post-board meeting statement on Tuesday following its decision to leave the official cash rate unchanged at 4.25 per cent, a move widely expected by economists.
"The board judged the pace of output growth to be somewhat lower than earlier estimated," Mr Stevens said.
"(It) also thought it prudent to see forthcoming key data on prices to reassess its outlook for inflation, before considering a further step to ease monetary policy."
HELEN KEMPTON and ANNE MATHER | April 07, 2012 12.01am
TASMANIA'S real estate industry, welfare sector and business community say a cut in interest rates would alleviate mortgage stress that is stymieing the housing market, driving some homeowners to bankruptcy or foreclosure and stopping consumers spending.
With the average mortgage at more than $210,000 in the December quarter of last year and repayments about $1500 a month, the Real Estate Institute of Tasmania (REIT) said a rate cut would give the sector the kickstart it desperately needed.
Housing costs are taking up more than 27 per cent of the average family budget.
As the Reserve Bank of Australia came under increasing pressure for not dropping interest rates last Tuesday, the Real Estate Institute of Australia continued to lobby the Reserve to drop rates next time it meets.
The recent separation in rate policy between the RBA and Australia's big four banks means the days of official cuts being automatically passed on to struggling mortgage holders are gone.
"We were hoping for a cut, especially to encourage first-home buyers back into the market," REIT president Adrian Kelly said. "It would really kickstart things. We were all hoping for a cut. Maybe next time."
The Reserve Bank's devotion to its inflation target was on full display this week. Indeed, Tuesday's decision to hold rates steady offers clear insights into the way the bank operates. Despite economic growth being 'somewhat below trend' and labour market conditions having 'softened during 2011' by the Reserve Bank's own admission, they are nonetheless waiting for the next inflation print before they possibly cut rates. Rather than trust its forecasts, it seems the Reserve Bank is very focused on actually seeing the trends in the CPI data. This is an important point for understanding its behaviour.
With only one policy instrument, the bank is well aware that it can only really have one target. While the Reserve Bank Act specifies three goals, including price stability, minimising unemployment and improving 'general welfare', the RBA's signed agreement with the government mechanises this in the form an inflation target. The RBA has decided, over a run of years, that the best way to meet all three goals in the Act is to set monetary policy consistent with maintaining stable inflation. Specifically, the bank seeks to maintain inflation 'between 2-3 per cent, on average, over the cycle'. Of course this requires that it is forward-looking in its approach.
But, at the same time, the Reserve Bank is highly sceptical about anyone's ability to forecast anything, including its own ability to forecast inflation. In a speech last year, Governor Stevens pointed out just how difficult it was to accurately forecast. He cited estimates suggesting that if "the central forecast for CPI inflation at a two-year horizon was 2.5 per cent, the chances of the outcome being between 2 and 3 per cent... would be about two in five".
This is where it really gets interesting, and where understanding the Reserve Bank's aversion to trusting forecasts can better help us understand the bank's reaction function. Given the uncertainties associated with forecasting inflation, the Reserve Bank often deems that the lowest risk strategy is to wait for the next inflation print, rather than move ahead of it based on forecasts. We saw this course of action vividly on display this week.
This approach partly reflects the idea that unless you are at a turning point in the economy, then a good guide to next quarter's inflation is last quarter's inflation print. This is because inflation is typically quite persistent. In an econometrician's parlance, the model that best fits the inflation process is an autoregressive model. We find that an autoregressive process usually fits well.
Clearly there is a trade-off here. Trust your forecasts more and move ahead of the CPI data, or, wait for the data but possibly fall into the trap of not being forward-looking enough. When push comes to shove it seems the Reserve Bank mostly thinks it is better off waiting. Last August's experience with almost lifting rates just before the third-quarter CPI print in October showed that inflation was much more benign than they expected, is probably still haunting the decision makers at the bank.
This focus on the inflation measures also means that all other economic indicators are subservient to the CPI data. To understand this it helps to come back to first principles. Let's start at the beginning. In simple terms, the bank sees its job as keeping demand growing in line with the supply capacity of the economy. The problem is that there are no perfect measures of demand or supply. It is actually often the case that a lot of the measures are indeed metrics of the intersection of demand and supply – for example, GDP.
While estimates can be made of demand and supply, they are imprecise. Indeed, while other central banks publish estimates of potential output (an estimate of supply capacity), output gaps (the gap between supply and demand) and estimates of the natural rate of unemployment (an estimate of labour supply capacity), the Reserve Bank is far more circumspect. They are cognisant that these tools are all estimated with error and also tend to be time-varying. In fact, an estimate of today's supply capacity may change down the track just because you have more information, not because anything has actually changed in the economy.
While you may think you have an estimate of the current output gap, revisions to GDP series – or imprecision in any of the other inputs into the calculation, such as capital, labour and productivity estimates – can bias your estimates. In the end you need to ask whether the imprecision in these estimates makes them subservient to an approach that just involves waiting a bit longer for the next CPI print. So the Reserve Bank's view seems to be that, at any point in time, the best guide to whether the economy is growing ahead of its potential is to look at whether inflation is rising or not. That is, if demand is starting to run ahead of supply then inflation will be rising, and vice versa.
This is why the bank is so obsessed with measures of the pulse of inflation. Adding to the complexity of the measurement issues is the fact that the headline CPI is often very volatile and not a good reflection of the intersection of demand and medium term supply capacity. Rather, headline CPI can be knocked around by one-off shocks. For example, headline CPI is affected by temporary supply side shocks, like flood effects on banana prices or the effect of political unrest on oil.
The bank has, therefore, developed a suite of underlying inflation measures that abstract from these shocks. These are its preferred measures of inflation, which include the trimmed mean and weighted median. Small movements in a well measured inflation metric are deemed one of the clearest signals that demand is running ahead of supply.
At the moment, the RBA's ongoing concern seems to be that weak productivity growth means there is still upside risk to inflation. Its fear remains that the mining investment boom could still stoke inflation, as it could push demand ahead of the weaker supply side of the economy. While the central forecast is for underlying inflation to fall into the lower part of the target band – it is currently in the middle of the band – they clearly attach a non-zero probability to the idea that inflation remains stubbornly higher.
The most persistent part of the inflation measure – the non-tradeables component – has remained uncomfortably high. In fact, the appreciation of the Australian dollar over recent years is the key reason why overall underlying inflation has remained contained and it looks as though the currency has stopped appreciating. If the first quarter inflation print – due on 24 April – shows that non-tradeables inflation persists at its current elevated level, it is clearly possible that the bank will hold rates steady again.
One thing that would help in this whole process, and a point we have raised before, would be to have a monthly inflation measure. Almost all other OECD countries have a monthly CPI and so do most developing economies.
Indeed, if Australia had a monthly CPI, there is a good chance the Reserve Bank would have cut rates this week. The alternative, of course, to having a more frequent CPI could be to have less frequent RBA meetings. Given their preference for waiting for CPI prints before moving rates, perhaps they should meet less frequently.
Paul Bloxham is HSBC's chief economist for Australia and New Zealand, and a former RBA economist.
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