In the shadow of a rates row

Interest rates are unlikely to shift today, but rumblings about the Reserve Bank board's consensus suggest not all of its members are singing from the same song sheet.

Property Observer

Today the RBA will likely keep its cash rate steady on the basis that it believes the economy is travelling around ‘trend’, inflation is sitting in the middle of its target band, and market lending rates are about where they need to be. To this line of thinking, rates are priced to perfection, or as close to perfection as one could reasonably expect to get.

And it is hard to see how Australia’s banks will undertake a second round of ‘out-of-cycle’ hikes given that funding costs have plummeted since their spike in January. By way of illustration, the Commonwealth Bank issued a AAA-rated covered bond at 1.75 per cent over its benchmark rate in late January. Today the cost of that same bond is 50 basis points lower at circa 1.26 per cent over.

As another indication, the Australian credit default swap index, which is a proxy for financial stress that measures market perceptions of the chance Australian companies will default on their loans, is today back around its July 2011 levels, and nearly 40 per cent lower than its late 2011 highs.

Having said that, we know that the RBA’s complex board is not always unified around interest rate decisions (in striking contrast to what some media commentators have claimed). Outgoing board member, Graham Kraehe, revealed in The Australian newspaper several weeks ago that the seven non-RBA members of the board, which include six dovish private sector representatives, had ‘regularly’ rolled the Governor’s (or ‘staff’) monetary policy recommendations:

"There have been a number of occasions when the basic recommendation from the staff hasn't been adopted…I would not suggest there has been an increase when the staff said there should be a decrease. But we (the non-RBA staff) have said, 'Let's not move, let's sit'…and that has happened reasonably regularly."

Note how Kraehe unwittingly concedes that the non-staff members of the board have never argued for higher rates, and confirms their implicitly dovish bias. This week we also had the ALP-aligned economist, Stephen Koukoulas, inform us that there are ‘many’ current board members who want to see lower rates:

"Whether the RBA cuts in March is not at all clear. There is no doubt it could (should) cut interest rate without fuelling a lift in inflation. This judgment is shared by many Board members.”

While the RBA’s meeting today should be something of a non-event for the economy, the data flows later in the week could have a decisive influence on the outlook.

The two key pieces of information we get are the fourth quarter estimate of real economic growth (or GDP) on Wednesday and the monthly unemployment rate update on Thursday. Recall that real GDP printed a ‘surprisingly’ strong 1.4 per cent and 1.0 per cent in the second and third quarters, respectively.

The RBA has argued in its Statement on Monetary Policy that Australia’s economy was actually running slightly ‘above trend’ in the second half of the year. In contrast, there are others, such as Koukoulas, who claim that the economy is actually much weaker than the RBA believes, and demonstrably ‘sub-trend’.

Tomorrow’s GDP results will help resolve this debate. The consensus economist prediction is around 0.7 per cent, or a touch under 3 per cent annualised. However, many analysts think that the risks are skewed to the downside. Goldman Sachs, for example, is forecasting just 0.4 per cent growth. Merrill Lynch’s Saul Eslake is similarly minded. The guys at Goldman have even canvassed a zero per cent outcome, which they correctly contend would be a ‘game-changer’ for the RBA.

Of course, if real GDP prints at 0.8 per cent or higher, and there are no fundamentally view-changing revisions to past data, the RBA’s comparatively optimistic position would be vindicated.

The GDP data could, therefore, materially alter the expected monetary policy path one way or another, which is obviously important for the highly interest rate-sensitive housing sector.

On Thursday we get another piece of the economic puzzle in the form of the monthly labour force data. In concert with recently robust GDP prints, the stubbornly low unemployment rate has frustrated those who were forecasting that the RBA would cut rates to as low as 3.5 per cent by June this year. In the last three months Australia’s unemployment rate has fallen from 5.3 per cent (initial estimate), to 5.2 per cent, and, in February, to 5.1 per cent.

Yet the RBA and most economists still expect it to rise to around 5.5 per cent.

As I have argued for months, a number of leading indicators insinuate that the labour market is healthier than many would have us believe. The much more comprehensive ‘unemployment benefits’ (or ‘dole’) data fell for most of 2011. Likewise, the Department of Education, Employment and Workplace Relations’ leading indicator index (red line in the chart below) has painted a more positive picture than the ABS’s numbers.


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Finally, growth in ANZ’s closely-followed job ads index has led its economists to conclude that the peak in the unemployment rate may, in fact, have already arrived (give or take the monthly volatility).

Notwithstanding this, many expect that the jobless rate will creep higher on Thursday. A surprisingly weak fourth quarter GDP estimate packed with a significant increase in the unemployment rate could energise the RBA’s currently tenuous ‘easing’ bias. Perversely, this would probably be good news for Australia’s housing market.

Based on RP Data-Rismark’s new ‘daily’ hedonic home value index, Australian dwelling values rose 0.8 per cent in February, but that only partly cancelled-out a slightly larger fall in the seasonally-weak month of January.

More encouraging are the partial housing data. Australia’s largest mortgage broker, AFG, has reported its best February month on record, processing $2.8 billion of new home loan applications. This compares to $2.0 billion in February 2011 and $2.2 billion in February 2010.

While some spin the ABS and RBA housing credit data by highlighting that it is at, or near, ‘at-time historical lows’, the truth is that new home loan growth is expanding at around the same pace as disposable household incomes. This is what one would expect, and is not be a harbinger of housing Armageddon.

Finally, there are some tentative signs in RP Data’s weekly auction clearance rates that the housing market may find a more solid base in 2012. We only have six weeks worth of data to go on, but, as the chart below shows, February yielded the best auction results since March 2011. There is seasonality in this data, so it needs to be interpreted with care. The one thing we can say is that this is certainly much better than the counterfactual of clearly deteriorating conditions…


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Christopher Joye is a leading financial economist and a director of Rismark International and Yellow Brick Road Funds Management. The above article is not investment advice.

This article first appeared Property Observer on March 6. Republished with permission.