The RBA's shameful 2012

With the exception of May-June, the Reserve Bank has been behind the eight ball all year. Our hollowed out economy is paying the price and, with a timid cut expected today, will continue to do so well into 2013.

Australia’s official cash rate should be ending 2012 around 2.5 per cent per cent but it is clearly too much to expect the Reserve Bank to cut 75 basis points to that level after it meets today.

More likely, the RBA will again drag the chain with a cautious 25 basis point cut to 3.0 per cent as it continues to worry about the inflation fairy at the bottom of the garden and maintains its faith in the Santa-like mining boom that keeps on adding to economic growth and capacity constraints. It may also continue its shadow boxing against a wage breakout that never quite materialises.

Right through 2012 the RBA has been as slow as a wet weekend to recognise and then acknowledge the pressures in the economy, most of which are dampening growth, limiting job creation and keeping inflation well and truly in check. It has also been scrambling to downgrade the mining investment outlook right through 2012 as a softer global economy and a ramping up in global supply in commodities filters through to lower income growth and inflation risks domestically.

At the start of 2012, when it was obvious inflation was falling, the global economy was undershooting already modest expectations, the labour market was stalling and fiscal policy was being massively tightened, the RBA refused to cut interest rates. After its usual and archaic practice of not meeting in January, the RBA held the cash rate steady at 4.25 per cent in February, March and April. These decisions not to cut are costing jobs and economic activity right now. Indeed, in every month since March, the number of job advertisements (measured by ANZ) has fallen and it looks like annual GDP will dip below 3 per cent when the December quarter national accounts are released in March.

Monetary policy was restrictive in early 2012 and the Australian dollar super strong. This was despite the fall in the terms of trade and decline in national income. It was only when the RBA got a stream of information confirming low inflation, a softer labour market, a tight budget and heightened negative risks globally, that it delivered a rare 50 basis point cut in May followed by a further 25 cut in June.

Those moves were very welcome and it appeared the RBA had thrown out its textbook of biases and taken a more measured view of economic risks and monetary policy management.

Alas, the RBA reverted to its early 2012 mode from mid-year and since June, despite a rise in the unemployment rate, unrelenting strength in the Australian dollar, a problematic global outlook, further fiscal tightening and further commodity price weakness, the RBA has delivered a single 25 basis-point cut.

An uptick in the September quarter CPI and some tentative evidence of a bottoming out of the Chinese economic slowdown were enough to see the RBA hold off cutting interest rates in November and before that, it was an uptick in house prices that seemingly prevented it from cutting. Disconcertingly, those house prices rises have unwound in the last few months.

The odd thing about the RBA and the September quarter CPI was that it was heavily influenced by the start of carbon pricing on July 1 and changes to the private health insurance rebate. These two items alone added perhaps 0.6 or 0.7 percentage points of the 1.4 per cent rise in the CPI. What’s more, the slightly better tone to the Chinese economic data has not been matched by higher commodity prices, which remain particularly soft. It is possible that the Chinese data, which are always unreliable, is giving a somewhat rosy view of the turning point.

Which brings us to the RBA board deliberations today.

It is clear house prices remain very weak and are lower today than at the end of 2011. Based on data in the TD-MI monthly inflation gauge, it looks like the December quarter CPI will be near zero, highlighting the fact that the bulk of the CPI rise in the September quarter was due to one-off events. True underlying inflation is probably tracking below 2 per cent.

In terms of public sector demand, the fiscal tightening now chomping away at economic activity is even more dramatic than appeared to be the case a couple of months ago. The labour market is also softening, a point showing up in a higher unemployment rate and benign wages growth.

The Australian dollar is trading around $US1.04 this morning – or about 77 on the trade weighted index. This is close to the level prevailing at the start of 2012 when commodity prices where more than 10 per cent higher. The elevated level of the Australian dollar is constraining growth, and while lower interest rates will have a slight dampening impact on the currency they will, more importantly, work to support economic activity.

It is a pity the RBA has had such a sanguine view on the Australian dollar and failed to see the hollowing out of the economy that is emerging on its watch.

The RBA needs to cut interest rates today and a 25 basis point move is better than nothing. If it cuts only 25 points, the economy will muddle along into 2013 and the over-valued Australian dollar will continue to restrict growth. It means there will likely be more interest rates cuts in 2013 and for the sake of the economy, it is to be hoped the cuts come through earlier rather than later.

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