The way I see things, the Reserve Bank’s interest rates decision (announced tomorrow at 1430 AEDT) will be a close one and there is a bit of a dilemma they confront.
The domestic economy as a whole (noting some areas of weakness) is travelling very well, and indeed partial indicators suggest that so far, domestic demand will be solid again in the third quarter. GDP itself (the numbers are out at 1130 AEDT on Wednesday) is expected to rise 1.2 per cent according to the consensus (me at 1.3 per cent). But it seems that business investment is surging and while mining in particular is extremely strong, investment was also solid in the manufacturing space and also in "other industries”. It was pretty much across the board.
Then household consumption looks set to be another decent contributor to growth, with retail sales for the quarter up 0.6 per cent – the strongest gain in over a year and so far, services have been stronger than that again. If that trend continues, we could get another sold consumer spending result this quarter.
So far, so good and the medium-term view is tracking well – with strong business investment and more modest, but still quite solid, consumer spending. This of course argues against a further easing at the bank’s meeting this week.
Then there is Europe and we know that domestically, housing is weak. The slump in approvals is particularly alarming.
With no solution forthcoming as yet, interbank lending, dollar funding and credit pressures have been developing gradually over the course of the year, as evidenced by a number of indicators. This of course is having flow-on effects and financial conditions have been tightening in Asia as European banks withdraw. Closer to home, the question I’m asking myself is whether the slump in approvals that we saw in some way reflects these deteriorating conditions – banks de-risking – or is it a demand issue caused by weak confidence? I don’t think we can really answer that question accurately with the information at hand.
More generally, financial conditions are still much better than what we saw in the build-up to the GFC and as the Fed has highlighted numerous times, US banks are having no trouble, putting them at a significant competitive advantage. But the indications aren’t good and pressures have certainly intensified lately, prompting the central bank action we saw last week. The fact that central banks took the action they did makes me wonder if something more sinister isn’t afoot. Again, I don’t want to pay too much attention to rumours doing the rounds that a European bank was at the verge of going under, but at the very least demand at the ECB’s main refinancing operation has been strong and they didn’t sterilise SMP activities. This also shouldn’t be overplayed, and as I mentioned at the time, the ECB may remedy this in future operations. But still, it is interesting to note this coordinated central bank activity and I don’t think we can ignore it.
So the question facing the RBA board is whether to participate in this coordinated central bank action in order to address deteriorating financial conditions in the short-term – even if to take some more insurance, as it were – or whether to focus more on medium-term issues and just sit pat on rates, making use of the strengthening domestic economy and signs of an acceleration in US economic activity to see what the Europeans come up with on December 9. Up front, I have no idea which path they will choose. They said they wanted a more neutral stance, and that we are broadly neutral, but then again they’ll still be broadly neutral after another cut.
Tactically, I think the best option is to sit back, wait to see what the Europeans come up with this Friday and save the ammo. If Europe does implode they will need all the ammunition they can get. Adding weight to that is some suggestion that banks may not pass on, in full, future cuts. That being the case there isn’t a lot of point just cutting by 25bps. Best off to hang back and cut buy 100bps or whatever if they really need to. There's the option to even call an emergency meeting in January if it comes to that. That’s my opinion anyway, but the board, as we know, are much more dovish than I am and could very well cut. It will be a very interesting meeting whatever the outcome. Note that the OIS and futures markets are fully pricing in a cut at this meeting, while economists seem evenly split (13 yays, 12 nays).
The RBA isn’t the only central bank that meets this week. Across the sea, the RBNZ meet but aren’t expected to do anything – rates steady at 2.5 per cent and the statement isn’t expected to change much. Then we see the BoE (no changes expected), ECB (a 25bps cut is forecast), BoC and BoK meetings as well.
Data wise, things are light in the US with the non-manufacturing ISM survey and factory orders out tonight. But other than that it’s really only the usual weekly indicators (jobless claims etc) and then trade data and Michigan University’s consumer confidence numbers on Friday. In Europe, its worth watching out for retail sales tonight, German factory orders tomorrow night and then industrial production figures for both Germany and the UK on Wednesday – look out for any news on European talks in the lead-up to the summit this Friday. Finally, and for China, industrial production and inflation figures are out Friday.
That’s pretty much it. Note that we get company profits and inventories for Australia today and the current account and public spending figures tomorrow – both very important feeds into third-quarter GDP.
Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.
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