Extracted from yesterday's Property Observer/Business Spectator article (read here for more):
Now to Australia’s central bank. While I will write more on this subject in the days preceding the RBA’s February meeting, it is perhaps most instructive to consider the options available to the bank.
Anyone who tells you that an interest rate cut in February is a ‘done deal’ is a fool. Frankly, nobody knows with certainty, including the RBA, what the outcome of that meeting will be. It hinges most heavily on three pieces of information that we will get over coming weeks.
First, the fourth quarter inflation data, and any revisions to the second and third quarter numbers. This will give the RBA a good feel for the nature of the inflationary pressures bubbling across the economy, and whether it was justified cutting rates in November on the basis of one low third quarter print. The consensus view is that inflation will be very benign in the fourth quarter, which will help the push for a rate cut in February (one economist thinks it will be negative!).
On the other hand, a high print, perhaps combined with some upward revisions to past data, would call into question the RBA’s recent decisions, and significantly reduce the chance the central bank doles out more ‘insurance’ to financial markets. A high quarterly number would be anything clearly in the top half of the RBA’s target 2-3 per cent band (annualised), or, god forbid, beyond.
The second key tranche of data is the December month unemployment results. While the overall tone of Australia’s real economic data has been positive, and, as the RBA has repeatedly observed, insinuates that the economy was tracking at or above trend during 2011 (abstracting away from the floods), there have still been some conflicting signals.
First, there was the very modest step-back in house prices, which look like they will finish the year off around 3 per cent. Then there has been some soft retail data based on the narrow monthly surveys, which have been refuted by the ABS’s much more comprehensive consumer spending data contained in the quarterly national accounts. This tells us that overall consumption spending has been tracking at or above trend over the six months to September.
And finally we have the labour market. While the number of persons on the dole has been declining consistently, and the number of job seekers receiving unemployment benefits has also been shrinking, the monthly ABS labour force survey has offered a more sketchy story: the closely-followed unemployment rate has been bobbing around 5 per cent for the best part of a year, with a marked drop-off in absolute employment growth.
Any spike in the December unemployment data will lend credence to the analysts who have swung around to forecasting a steady increase in Australia’s jobless rate from 5.3 per cent today to over 5.5 per cent during 2012 and, combined with anodyne inflation data, would give the doves on the RBA’s board enough ammunition to lock-in another interest rate reduction.
Our final consideration is, as always, the pulse of the global economy, and eurozone conditions specifically. Although Europe itself only contributes a relatively small fraction of global economic growth, which is why the US, India and China have managed to weather its headwinds relatively well, the RBA seems increasingly prone to bowing to pressure from the banks and financial markets to dole out scarce monetary policy insurance to protect these constituents against ‘tail risks’.
As you can tell, I don’t think this is an especially astute strategy, and would have exercised the 'option to wait', rather than boxing at manufactured shadows. Nevertheless, one curve ball is bank funding costs.
If, hypothetically, the eurozone crisis gets much worse, and the wholesale price of money that banks have to pay – which accounts for about 30 per cent of their total funding – continues to rise (no one seriously disputes that it’s been increasing), the RBA might be convinced that to preserve current lending rates it needs to further lower its target cash rate.
This, crucially, assumes that the banks and their shareholders cannot absorb the higher funding costs themselves via lower net interest margins, lower profits, and lower returns on equity, which, at this stage, remain very high for government-guaranteed utilities.
Fortunately for borrowers, but not savers, none of the above contingencies countenances rate hikes. There is, by definition, some small probability that the next move in interest rates is not actually down.
If you believed the average or ‘consensus’ economist view 12 months ago, you were budgeting on another three to four rate hikes. If you believe the average or ‘consensus’ economist today, you are banking on another one to two cuts. The truth is nobody knows, and the RBA will be guided by what actually happens in the real world.
