RBA needs clarity on the fiscal front

Don’t hold your breath waiting for the next interest rate change; the Reserve Bank of Australia sees signs that the economy is improving but is happy to wait this one out.

At its board meeting today, the RBA surprised nobody by holding rates steady at 2.5 per cent -- the sixth consecutive meeting without a change. This period of inactivity is set to continue over at least the next few months, with the RBA giving a clear sign that it intends to leave rates unchanged for some time.

When the central bank is likely to shift its tone is open to conjecture, as is what direction that tone will take. The reason for leaving rates unchanged isn’t so much that the economy is in a sweet spot but that the outlook is particularly uncertain.

By my reckoning the strongest signal since the last meeting was the ABS data on capital investment intentions, which clearly indicated that mining and manufacturing investment is set to decline sharply over the next couple of years (Business is preparing for a capital strike, February 27).

The business investment collapse was widely expected, particularly by the RBA, and certainly didn’t take it by surprise. But the magnitude of the collapse is significant and will be difficult to offset, particularly given the manufacturing sector is set to simultaneously contract.

On the other hand, global growth prospects have improved. Exports are rising strongly, driven by the resource sector, and housing activity is expected to rise. Though with regards to housing construction, I remain unconvinced (Why the high rise is not a tower of strength, March 1).

The RBA, however, is convinced that it has done enough for now but clearly it could go either way. In my opinion the big uncertainty is the Coalition’s budget in May. The government’s rhetoric has been strong, with a clear desire to cut spending not only in the next financial year but over the forward estimates.

But whether they go through with those cuts is the big question, particularly given their recent slump in the polls and announcement of a ‘growth target’ at the G20 meeting in Sydney. If the budget cuts are larger than expected, they will weight on economic growth over the next few years and prompt the RBA to act. Similarly, if the Coalition gets cold feet the government may in fact boost the economy and give the RBA the opportunity to raise rates.

After a one-meeting reprieve, the RBA continued its attempt to talk down the Australian dollar. The approach proved successful initially but has since lost much of its lustre as it became clear that the RBA’s words were exactly that -- words -- and the bank was reluctant to act.

The RBA also flagged that unemployment is set to rise in the near term but will turn around once growth picks up. I’m concerned that the lack of business investment will weight further on jobs which, combined with an ageing population, could result in a prolonged period of weak employment growth.

The RBA has sent a clear signal at the board meeting today that it is happy to sit back, relax and take stock of the economy before making the next move. It is understandable given the considerable uncertainty surrounding the domestic economy. In my opinion it is unlikely that they will do anything before the Coalition hands down its first budget in May.