Well, I did not believe the futures market's baloney (ie, pricing in less than one hike in 2011), and the lemming-like behaviour of economists pushing back their rate calls into Q2 and Q3 on the basis of nebulous remarks from the Governor in parliamentary testimony—who, it should be noted, has little upside in appearing hawkish right now. Nor was I swayed by an exceedingly nondescript RBA statement after Tuesday's Board meeting, which was clearly an exercise in saying nothing.
The bottom line is that the RBA does not know exactly what is going to happen in 2011, but if their hawkish 'central case' proves out we will see rates shift into genuinely restrictive territory. This means that lending rates will head back towards 2007-08 levels. And there is nothing wrong with that. This is just the high-quality problem one has to manage when you avoid a recession during the GFC and get to be the beneficiary of the biggest investment shock that has taken place in around 100 years.
Naturally the Gillard Government always has the option of doing some of the heavy-lifting for the Bank. They can cut the fiscal stimulus more quickly, and on a much more targeted basis than the indiscriminate instrument that is monetary policy. But don't hold your breath.
The bad news for financial markets and most economists head-faked by the RBA's decision to say nothing meaningful following the November Board meeting was that today's employment data very much vindicated the Bank's upbeat central case (ie, ignore Q3 GDP and focus on unemployment and GNI). That must mean that Q1 is live. Ross Gittins confirmed as much last night. He thinks February is on the cards. I don’t have a view over February or March. I just think the market was mispricing the probability of a hike.
A great deal will depend on the January employment and inflation prints. Further out, the magnitude of any hikes will also be influenced by the extent to which the ‘cautious consumer’ stays in his box (ie, watch consumption closely). Contrary to what the RBA would have us believe, this caution has nothing to do with risk-aversion and everything to do with rates. Of course, it sounds vastly more flattering to hear that consumers have voluntarily decided to deleverage their balance-sheets in recognition of the fact that the probability of catastrophic loss is much higher than they once thought. The problem with this logic is that the Aussie consumer never had to learn this lesson. It is the mixed blessing borne from our good fortune. And it probably means that Australians will be the guinea pigs when GFC Mark II emerges out of Asia in one or two decades’ time.
During the recent episode, the average Aussie kept their job, experienced a large increase in disposable income (care of massive government hand-outs), saw their cost of debt fall through the floor, and benefited from relatively stable house prices.
And this was meant to be the worst crisis they had faced in 75 years, or so the public were relentlessly told. In Australia, the lasting impact of the crisis is unlikely to be persistently elevated risk aversion. The much higher probability outcome is complacency and hubris.
For the record, there is a good reason why Australia’s household savings rate is at its highest level in a long time: with 6-7 per cent term deposit rates, the risk-free opportunity cost of consumption is the highest it has been in around 15 years. Combined with the fact that consumers now understand that Australian shares are an incredibly hazardous asset-class (with annual volatility over the last 30 years of about 19 per cent assuming you are not geared), they are rationally allocating more of their capital to the area that offers them the best risk-adjusted returns: cash.
When thinking about the future, the most important thing to bear in mind is that there is scant upside in this RBA exercising excessive caution. As the Governor explained the other day, when you are certain it is time to lift rates, it is too late. And the RBA always have the option of changing course. Yet once inflation and expectations of future prices start drifting upwards, they tend to persist and can be far harder for the central bank to reverse. A more rigid labour market will not help the RBA sleep at night either.
In exceptionally trying circumstances, this RBA has mostly got monetary policy right. Perhaps more significantly, they have learnt from their mistakes in 2006 and 2007. And I think they are imbued with a healthy dose of humility. For ‘the time being’ (subtle code for rate watchers), one has reason to have faith in their judgment.
