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Friday, August 5, 2011

Nuances to RBA thinking--provided by Paul Bloxham

Good work by Blocko...

- The RBA has very actively moved into talking about the supply-side of the economy, by discussing recent weakness in productivity. As monetary policy has no impact on productivity, this is quite unusual for the RBA. They usually stay in their patch. Clearly, persistently weak productivity growth is a further upside risk to inflation, so it has been actively covered in the official statement.

- The RBA reiterate the risk around the recent cautious behaviour of households. Their central forecasts assume continued caution, ‘with a modest increase in the saving ratio in the near term’. The risks go both ways. If households cheer up a bit and spend, then this will put upward pressure on inflation. But they could continue to hold off, which will help get inflation back in the band. Importantly, it is interesting just how little emphasis the RBA gives to the weak retail story and indeed the retail statistics.

- The RBA seems unconcerned about the recent modest decline in housing prices and the increase in mortgage arrears. They point out that arrears are still at very low levels by international standards and that the pick up has been localised to cohorts in Perth and Brisbane, where housing prices rose sharply prior to the GFC and then fell more recently.

- The RBA seems far less concerned about the multi-speed economy than others. A box in the official statement shows that non-mining parts of the economy have so far continued to grow solidly. Although clearly some parts of the non-mining economy have been affected more than others.

-Bottom line

Inflation is rising, productivity is weak and the mining investment boom is huge and seemingly unstoppable. While there are divergences across the economy, the RBA seems fairly relaxed about them. On its own, this is a recipe for higher interest rates.

But recent sovereign debt problems in the US and Europe are a significant downside tail risk to the outlook, and these have kept the RBA on hold recently. How they play out will be critical for the next RBA move.

Our central case assumption remains that the next rate move is up, though clearly the risks around that forecast have become heightened.