The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Wednesday, June 22, 2011

The RBA is not a pre-emptive central bank

Much was made of the RBA's decision to hike rates in November last year when inflation was subdued. I am pretty sure that this was the first time the Bank had moved the cash rate into genuinely restrictive territory on a pre-emptive basis. The Bank itself was keen to talk-up its forward-looking policy setting process. But almost everybody agrees that the RBA is now driving policy via the rear-view mirror. The RBA yesterday made it clear that it was data-dependent despite the worryingly high CPI outcomes in the first quarter of this year, despite what it describes as above-average wage growth, and despite its 'central case' of a resources boom sucking out any remaining spare capacity in the economy being absolutely on-track. If the RBA was genuinely pre-emptive it would have hiked in May or June. After arguing for so long that it has to set policy in the best interests of the overall economy, and that we should mostly ignore signs of a two speed economy (eg, weak retail and housing, which is what it has been hoping to see), and, most bizarrely, that we should ignore high-frequency monthly data flows, it is now suggesting that we have to, in fact, pay attention to this stuff to mount the case to hike rates. ICAP's Adam Carr puts it nicely:

"With that in mind I think it should be clear that we’ve just witnessed a fairly significant back-flip, based on not so significant dataflow. I’d be a little more understanding if the Bank had just noted concerns over Greece. That probably would have been fair enough. But they didn’t leave it there. Indeed Greek concerns were listed last, almost as an afterthought. Much more prominence is given to some of the softer domestic dataflow and the two speed economy – things they explicitly downplayed only a month ago and suggested they would overlook...

Clearly the RBA hasn’t changed its view, so in reality the only thing that could have changed is the perception of the board. The debate leading up to the June meeting was hysterical - rabid even and this has clearly weighed heavily. Why this is important is because, and as I’ve suggested previously, it means the bar for another rate hike is very high. As I feared, the RBA (to the extent they are more hawkish than the board) will be less able to act pre-emptively now. This means that the dataflow needs to be unequivocally strong and that sentiment needs to pick up – probably markedly. The board seems to want proof.

The thing is, I just don’t think we are going to see that proof over the next few months, nothing that will add "any urgency to the need for an adjustment to policy". Housing will probably be weak for most of this year, equity gains are likely to be modest and consequently, ‘the community’ won’t see the need for further rate hikes for quite some time (if ever) and that probably means the board won’t see the need. That’s more a late 2011 or even a 2012 story.

I guess a high core CPI in late July, might be sufficient, if sentiment has improved by then, but that can’t be assured in this environment. The board makes it clear they are waiting for “further data on international developments, and on the strength of domestic demand and inflationary pressure”. While we get CPI data and should know if Greece is going to default by then, we don’t actually get a lot of domestic demand data. Things are in a state of flux, but the best bet now and until we see the actual dataflow, is to assume no rate hikes till later in 2011 – perhaps October or November (market pricing in 30% chance of a cut)."