Hold on, there's no cut coming today

The falling Australian dollar, and early signs of a rebalancing from mining investment to exports and household consumption will likely see the Reserve Bank hold fire. But August will be a different story.

Interest rates will almost certainly remain on hold at 2.75 per cent today when the Reserve Bank of Australia announces the outcome of this morning’s board meeting.

The decision to leave interest rates unchanged should be reasonably straightforward, not least because there is clear evidence of an uptick in the interest rate sensitive sectors of the economy, in particular housing and consumer spending. On the down side, there is no doubt that mining investment is in the early stages of decline and this will be a drag on economic growth over the medium term. It is likely to be a key point that will see the Reserve retain a bias to cut interest rates, “if circumstances permit”.

Adding to some of the downside risks is a renewal in the problematic outlook in China, while the deep recession in Europe remains in place, even though there are some very tentative signs of a bottoming in activity. Better economic news from the US, Japan and India should counter this pessimism, at least for now. The bottom line is that global GDP growth will be stronger in 2014 than in 2013, even if the drivers of that growth are changing.

The lower Australian dollar in itself is not a reason why the bank will hold off cutting interest rates, but the recent fall to around 92 US cents will provide some stimulus to the export sector and it will assist those local firms competing with imports. Already, there is some tentative evidence that the lower Australian dollar is unpinning the economy. The AIG performance of manufacturing index jumped 5.8 point to 49.6 points in May.

While the TD-MI monthly inflation gauge is yet to capture any significant price effect from the lower dollar, the Dun & Bradstreet Business Expectations Survey shows businesses are increasingly of the view that their selling prices will edge higher during the September quarter.

In terms of the economic growth outlook, the Reserve Bank is likely to hold a central case where GDP will be a little below trend over the remainder of 2013, but will be lifting back to 3 per cent, or a touch more, into 2014. The bank is forecasting a rebalancing of economic growth away from mining investment towards exports, housing and household consumption. The early signs are suggesting that this scenario is unfolding, but more evidence will be needed for it to be convinced that the pick-up in the domestic economy is sufficient to see real GDP growth pick up to a 3 per cent pace.

If there is a surprise today, it will be the Reserve cutting interest rates and using the expected decline in the terms of trade and likely rise in the unemployment rate as reasons.

Commodity prices are trending lower. Since the start of February, the broadly based Thomson Reuters/Jefferies CRB index of commodity prices has fallen 10 per cent. It suggests a further drop in the terms of trade in the June quarter and weak momentum into the second half of 2013. The Reserve Bank’s own index of commodity prices has fallen 27 per cent in US dollar terms from the 2010 peak – in Australian dollar terms, the index is 18.5 per cent below its peak.

At the same time, all of the available leading indicators for the labour market paint a disconcerting picture for jobs growth and the unemployment rate over the next six months. The ANZ job ads series, the ABS measure of job vacancies and the Dun & Bradstreet business expectations survey employment index are all weak. All suggests a stalling in job creation and a rise in the unemployment rate from the current 5.5 per cent to 5.75 or even 6 per cent by late 2013 or early 2014.  

If the Reserve Bank is of the view that these leading indicators of the jobs market are reliable and there is a genuine risk of the unemployment rate rising at an uncomfortably fast pace, an interest rate cut today would help tackle any such trend.

As always, the Reserve is likely to wait for the next official inflation reading before acting on policy. The June quarter consumer price index is released on July 24, just two weeks before the August meeting of the Reserve Bank board. At the August meeting, the bank will also have two more monthly readings on retail trade, a better guide to what is happening globally and more context on the Australian dollar/commodity price mix.

A low inflation reading, as looks likely, will give it easy scope to cut rates in August. For now, it is a likely ‘on hold’ decision with a firm bias to ease.