RBA eyes what lurks beneath

There was never any real expectation that the Reserve Bank would cut official interest rates this month despite the clear signs that the first phase of the resources boom is ending and some indications that the rest of the economy is again deteriorating.

As far as the RBA is concerned, economic growth, supported by the investment phase of the mining boom, is running close to trend, inflation is low, interest rates are a little below their historical averages, the housing market has stabilised, business credit has picked up and there's moderate employment growth.

Viewed through that lens, the Australian economy is having one of those Goldilocks moments where most of the settings are just about where the RBA would like them to be.

Beneath the aggregates, of course, there are some disquieting developments. There had been some hope that the Gillard government's latest "cash splash" in May and June might have helped put a floor under the recessed consumer confidence and spending levels.

This week's retail sales numbers suggest that it ignited a momentary consumer spending and gambling binge and then the consumers zipped up their wallets.

Almost every day there's another company collapsing or a major job-shedding program announced. The ANZ job ad series this week saw a material decline in the number of jobs advertised. Demand for credit remains weak.

In the resources sector, while there are $260 billion or so of projects underway, mainly in the LNG sector, commodity prices have crashed and the pipeline of future projects is diminishing on a daily basis.

BHP Billiton's decision not to proceed with the $30 billion Olympic Dam project and the $20 billion Outer Harbour expansion at Port Hedland may have been the most visible but it is unlikely that the $300 billion or so of uncommitted projects will get a go-ahead in the current conditions.

Fortescue's decision today to chop 25 per cent out of an expansion that was scheduled to be completed next year is a signal that even some of those projects that are already committed and underway might be pulled or amended.

There has been, and will continue to be, increased production and export volumes as a consequence of the investment that has already occurred but the overall benefit from that investment is going to be sharply reduced by the collapse in commodity prices that has occurred as China has slowed.

Plus, while the Gillard government has promised to deliver a budget surplus, the combination of reduced revenues from the minerals resource rent tax and company profits and its own continued large-scale spending promises means that to produce something that looks like a surplus is going to have to involve really savage new spending cuts within the context of a weakening economy.

Good luck with that – but if it can produce anything close to a balanced budget it is going to have quite a contractionary impact on the already stressed non-resource sectors.

The RBA is aware that conditions aren't quite what they might appear from the numbers. The global economy has weakened, Europe is a basketcase that could yet destabilise the global economy and financial system and the US is struggling to generate growth.

China had been the hope of the side but its growth has weakened despite the efforts of its policymakers to arrest the slowdown and ripples from what some are now describing as a "hard landing" in China are spreading throughout Asia.

The sliding growth rate in China and the consequent fall in its demand for commodities have coincided with a surge in the supply of commodities; a coincidence that explains the steep price declines and the cancelled or mothballed projects.

Despite the fall in commodity prices and the obvious pressures on the resource sector that has under-pinned domestic economic growth the Australian dollar remains, according to the RBA, "higher that might have been expected given the observed decline in export prices and the weaker global outlook".

Even as the resources cycle has peaked the dollar continues to impose pressure on the rest of the economy, particularly manufacturing.

The RBA might appear to be sanguine about the state of affairs and the outlook and comfortable that monetary policy settings are appropriate for the current condition of the economy but it would be alert to the very real prospect that the confluence of adverse factors now developing here and abroad may have some nasty implications for the domestic economy.

From a tactical point of view keeping its somewhat diminished powder dry and the cash rate at 3.5 per cent, even if it continues to prop up the Australian dollar, is a sensible precaution in case everything within the global environment that can continue to go wrong does and forces its hand.