The RBA's interest rate playbook

The RBA's economic charts highlight how reliant Australia has become on China. They also show an economy where most major indicators are generally pointing in the right direction.

Being asked which is your favourite chart in the Reserve Bank of Australia’s monthly chart pack is a bit like being asked which is your favourite child. Each month, the day after the meeting of the board, the Reserve Bank publishes the charts that would have been used as evidence to support the Bank’s analysis of the economy and financial markets and would have been the centerpiece of discussion at the meeting.

It is essential viewing.

There is one chart, nonetheless, that probably captures the essence of Australia’s recent economic history and spells out where the future lies. It is Exports by Destination, which shows the change in the direction of exports over the past 15 year or so.

The striking feature is the emergence and then dominance of China. The 1990s ended with China taking just 5 per cent of Australia’s exports. In 2013, this had risen to over 25 per cent and it has increased further through the course of 2013. Europe and the US combined, took over 25 per cent of Australia’s exports in the late 1990s and this has dropped to around 13 per cent. India and South Korea are more important export markets than the US and it is all but certain that Europe will drop below these countries in the next couple of years.

Graph for The RBA's interest rate playbook

There is an incredible range of other information in the central bank charts that are worth a look. While I have clearly cherry picked the charts below, these are the ones that would have been used to argue against a further interest rate cut or indeed, that the next move in interest rates should be up.

In terms of Australia’s major trading partners, there clearly has been a consolidation in the growth at around a 4 per cent pace. With stimulus being maintained, the Reserve Bank is a little more optimistic about the growth outlook for the world, even though risks remain.

Graph for The RBA's interest rate playbook

While inflation is currently comfortably within the Reserve Bank’s 2 to 3 per cent target band, most of the underlying measures are no longer falling – they may even be ticking a little bit higher. The September quarter inflation data, coming out later this month, will be vital to confirm whether some of the inflation risks have been benign or not.

Graph for The RBA's interest rate playbook

While not a massive influence on policy settings, consumer sentiment does give some useful information of the prospects for spending and borrowing from the household sector. Sentiment has jumped by 10 per cent in the last two months to be well above its long run average.

Graph for The RBA's interest rate playbook

House prices are clearly moving up, albeit from a lowish base. All of the losses between 2010 and early 2012 have been recovered at the national level and with interest rates currently at record lows, it seems certain more house price gains will occur. The Reserve Bank will not want this recent upside momentum to turn into a gallop.

Graph for The RBA's interest rate playbook

The home loan approvals data are similarly showing an upswing.

Graph for The RBA's interest rate playbook

Despite some of the (legitimate) anxiety over the recent labour force data because of a weaker trend, annual employment growth remains reasonably solid at around 1 per cent while total hours worked is strengthening. It suggests firms are working their existing workforce harder before deciding to add staff in a more formal way. There is also some prospect that employment will bounce-back in the few months after the election. 

Graph for The RBA's interest rate playbook

The fall in the terms of trade has been moderate and recent commodity price trends suggest further sharp falls are unlikely. Even a further 5 or 10 per cent drop in the terms of trade over the next year or so would leave them well above the long run average. 

Graph for The RBA's interest rate playbook

Global bond yields have been moving higher on the back of heightened inflation risks and a realisation that central banks will start to reduce the amount of monetary stimulus in the economy. At the moment, the back up in yields is not yet signaling strong economic growth with high inflation, but the bond market tends to be forward looking and alert to these risks.

Graph for The RBA's interest rate playbook

Critically important, monetary policy in Australia is very easy. The average interest rate paid by the business sector has never been lower. With some leading indicators turning higher, more monetary stimulus is not needed.

Graph for The RBA's interest rate playbook

And finally, the bank’s non-performing loans are low and falling, which suggests the current easy monetary policy settings are working. These low levels of non-performing assets are potentially a risk from the point of view of the banks allowing some relaxation in credit standards and borrowers wanting to take on more debt.

Graph for The RBA's interest rate playbook

In all, the charts highlight some positive aspects about the economy, markets and just possibly some inflation risks, but for now, it is clear why the Reserve Bank left interest rates on hold at a record low level earlier this week. Watch out for the next chart pack to see whether these and other charts show turning points in the key indicators.