Redemption beckons for the RBA

The need for a rate cut is clear given a recent growth slowdown, rising unemployment and muted inflation. The only question is whether pig-headedness will stop the RBA fixing past mistakes.

A 25 basis point cut in the official cash rate should be close to certain when the RBA board meets today.

It should be a simple decision given the trio of slowing economic growth, a rising unemployment rate and inflation hovering near the bottom of the target band.

These simple inputs into the monetary policy discussion are complemented by a deteriorating outlook for the jobs market, the increasingly misaligned Australian dollar, a still problematic outlook for the global economy and confirmation that fiscal policy will be contractionary over the next year or two at both the federal and state level.

It seems a long time ago now but since the last RBA meeting, the October labour force data showed the unemployment rate rising to 5.4 per cent, a 30-month high and 0.5 per cent higher than the recent low. This is worrying enough but the ANZ job ads data, which is a reliable leading indicator of labour demand, has fallen for seven straight months and at current levels is pointing to the unemployment rate hitting 6 per cent in early 2013. It has been almost a decade since the unemployment rate was above 6 per cent and it is something that needs to be, and can be, avoided with lower interest rates.

There has also been confirmation in the MYEFO that fiscal policy will be cutting around 1.5 percentage points from GDP in 2012-13, meaning that easier monetary policy is needed to boost private sector demand and help it take the place of a receding public sector.

In terms of inflation, the September quarter CPI was a little higher than the RBA (and the market) were expecting, but in annual terms, it was only 2.0 per cent with the underlying measures at 2.5 per cent.

That said, there was some difficulty interpreting the CPI data due to the start of the carbon price and scaling back of the private sector health insurance rebate, both one off events that accounted for close to half of the overall CPI rise. Yesterday’s release on the TD-MI Monthly Inflation Gauge, which rose just 0.1 per cent in October, suggests the broad underlying inflation pressures are very low. Indeed, the run of monthly inflation data suggests the December quarter CPI could dip back to around 0.5 per cent.

It is also noteworthy that capital city house prices fell 1.0 per cent in October, reversing the bulk of the September gain and leaving prices are more than 5 per cent down from the 2011 peak. At the same time, housing credit growth has slumped to a fresh record low (data back to the 1970s). It is impossible to construct a view that the current level of interest rates are supporting a lift in housing demand or even more absurdly, that a house price bubble is being unleashed.

It is also worth noting that retail sales in volume terms fell 0.1 per cent in the September quarter as the benefits of the carbon compensation unwound and as consumers continued to pay down debt and build savings. Higher savings and lower debt are to a large extent welcome, but if they go too far they risk undermining growth and with it, employment.

The Australian dollar, which has held a remarkably stable and high level over the past month around 1.0350, has further decoupled from commodity prices. This is a major concern and is the greatest threat to the domestic economy. The RBA’s own index of commodity prices fell a further 3.5 per cent in SDR terms in October to be 16 per cent down over the past year. In stark contrast, the Australian dollar has risen about 1 per cent against the US dollar and on a trade weighted basis in the past month and more worryingly, it is unchanged from when commodity prices were at their highs.

These jaws of death – the gap between the level of the dollar and Australian commodity prices – is damaging the import competing sectors and exporters. Many of these companies have, through no fault of their own, lost competitiveness given the grossly misaligned level of the Australian dollar. Had the dollar eased to around 90 cents, their competitiveness would have been enhanced. It hasn’t and the RBA needs to act.

The RBA has been dragging the chain all the way in the current rate cutting cycle. It has been slow to move. In the early months of 2012, it refused to believe the economy was cooling or that the sharp fall in inflation would be sustained. Only when it was clear its reading of the economy was wrong, it caught up with 75 basis points of cuts in May and June.

The RBA pig headedness returned after that and it paused the easing cycle in July, August and September, despite weak employment data, falling job advertisements, a problematic lead from the global economy and a persistently high dollar. Thankfully it resumed the rate cutting mode in October and if it is to do its part to underpin the economy into 2013, it will cut again today.


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