The rate cut dash is done and dusted

The Reserve Bank of Australia meeting today is a proverbial no brainer – there will be no change in the cash rate from the 2.5 per cent level set by the bank when it met last month.

This does not mean that the meeting of the board and its deliberation over interest rates will not be hugely interesting – it will. Discussion over which areas of the economy remain soft, which are either turning up or are already strong will no doubt be argued around the table. For the Reserve Bank staff, it is likely to be the more positive news that will be gaining focus because it is starting to signal a return to trend GDP growth in the not too distant future. With this comes heightened risks of higher inflation sometime in the next year or two.

The Reserve Bank board will likely agree that the flow of hard economic news in the past month has been erratic, albeit with a slight tilt towards the upside.

In no real order, the positive signs for the economy are showing up with house prices continuing to increase and business investment recording an unexpectedly strong rise in the June quarter. There are also very clear signs of an improvement in global economic conditions and a lift in commodity prices, all of which will work to support the Australian economy.

Add to that an above trend level for consumer sentiment, a moderate but clear uptick in new housing construction, a strong lift in export volumes, fiscal policy has moved to neutral and there has been a slight upturn in credit growth. This mix of news should be enough for the optimists around the board table to hang their hat on.

This optimism is enhanced by the recent depreciation of the Australian dollar, which remains more than 15 per cent lower than in April. This new level for the currency, if sustained, is likely to provide a further boost for already strong exports and it will help those firms competing with importers. The lower dollar will also bias inflation a touch high both directly through higher import prices, but also through its stimulatory impact on the economy.

The TD-MI Monthly Inflation Gauge, released yesterday, shows an inflection point for inflation in the last few months. The September quarter CPI looks like rising 0.7 per cent.

Those on the Reserve Bank board with a less positive view of the economy will also have some high profile facts to support their case.

Most important is the slower rate of job creation and the moderate rise in the unemployment rate in recent months. While labour market conditions lag the business cycle and will be the last thing to track a stronger rate of economic growth, the jobs softness and the still negative lead from the forward looking indicators of employment – job advertisements and vacancies – suggests that the unemployment rate will tick up towards 6 per cent by the end of 2013 or in the first part of 2014.

This clear softening in the labour market is also showing up in weak wages growth which, according to the wage price index, is rising at an annual pace of a tick below 3 per cent. This is one of the lowest rates on increase in wages seen in several decades. Low wages growth is a key input into the near-term inflation outlook and if recent trends remain, the forecast pickup in inflation will be moderate. 

Adding to that less-than-robust news is the weakish level of business confidence – confirmed in the recent Dun & Bradstreet survey but also in the NAB business survey. While confidence is fickle, a stronger economy is normally associated with a more buoyant level of optimism from the business sector.

An interesting aspect of the recent capital expenditure survey form the Australian Bureau of Statistics was that the expected level for business investment for the year ahead was subdued. This was despite the unexpected strength in investment in the June quarter.

It still looks like business investment will be weak – perhaps down 5 per cent – in 2013-14.

It is also evident that retail spending is only mediocre with consumers still adding to savings and in many instances, paying down debt.

The end point is that interest rates are on hold not only today, but also for the next few months. The interest rate debate is slowly shifting away from when the next rate cut will be delivered to whether there will be a rate cut at all. 

If the run of good news gathers pace in the months ahead, the debate will start to focus on when the Reserve Bank will deliver the first interest rate hike in the new cycle.