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."

Monday, November 21, 2011

Will they or won’t they in December?

While it is not currently part of the RBA’s game-plan, there are some economists out there pushing hard for a December rate cut. They include independent operator Stephen Koukoulas (who puts a December cut at a near-certain 95% probability), UBS's rates man, Matthew Johnson, and Goldman Sachs's gun Tim Toohey.

Matthew, who has become especially dovish based on the view that Europe is heading for recession, was referenced in The Australian on the weekend arguing there is a chance of a 50 basis point cut in December.

Perma-dove, David Uren, uses this as partial justification for the claim that "the Reserve Bank is under pressure to cut rates again before Christmas amid fears that Europe is dragging the global economy into a new recession."

I don't think Martin Place is under pressure to do anything at the moment. If it cuts in December, it will be because of a substantial deterioration in European conditions, or some other exogenous shock that is not currently on their radars (eg, Israel launching military strikes against Iran). Accurate rates watcher, Alan Mitchell, pulled out his 12 gauge in the Weekend AFR and blew out of the sky some of this dovish sentiment:

"The RBA, on the other hand, has made it abundantly clear that another cut in the official cash rate in December is definitely not on its agenda. The minutes of the Bank's November board meeting, made public on Tuesday, portray the November rate cut as a once-off adjustment. Additional cuts will follow in the near-term only if there is a change in the economic outlook."

He goes on to say that the Government would have to make massive, permanent cuts in its mini-budget of between $4 billion and $10 billion to justify the RBA considering a further reduction in its cash rate.

Will they or won’t they? While a December cut may not be the RBA’s current base-case, it will not make up its mind until right before the meeting, and could even change that position on the day of the discussion. More generally, a few thoughts spring to this humble mind:

1/ Any proposed cuts by the government must be contextualised against new pre-election spending and pork-barreling given the fragile coalition between the Greens and Labor, and the fact that this government may (will?) lose the next election. That is, any political commitments to austerity may need to be discounted somewhat;

2/ The RBA has time on its side, and has invested significant political and reputational capital in the argument that this was a once-off adjustment in its cash rate to a neutral setting. By end January it will have a raft of inflation, GDP and unemployment data with which to reassess its position. Just like in October, it would be potentially rash for the RBA to move policy before all this data is released save for a genuine European implosion that derails the global economy. There is greater policy elegance associated with cutting in February if the doves get the data they are pecking around for;

3/ Whether the RBA goes in December or February (assuming it actually needs to) is not really going to change the price of eggs in China. One month here or one month there over the summer break is not going to make much of a difference to the Aussie economy in the scheme of things. There is certainly no domestically-driven urgency to cut rates in two weeks;

4/ The extraordinary inversion in the yield curve, whereby the longer-term price of money keeps falling way below current interest rates, combined with another round of currency weakness, is already delivering de facto cuts, and possibly more than the RBA was banking on. The SFE’s 30 day interbank futures contract is currently pricing in a sub-3% RBA cash rate by the second half of next year. The 3 year government bond rate is heading towards 3%. This means more falls in already below-average interest rates on fixed-rate home loans, and lower term deposit rates. That will in turn mean less consumer saving, and more spending and borrowing; and

5/ Finally, in the unlikely event the RBA’s cash rate does go close to 3% (ie, the same level it hit during the GFC), it is going to be party time again for the Aussie housing market. As in 2009-10, the market will bounce back strongly if folks start paying variable rates of 5.0% or less (cf. current rates of around 6.7%). That’s why housing is, contrary to popular myth, a good hedge against adversity.