Wait on the size of the RBA's bang

The words of the Reserve Bank of Australia are unequivocal.

“The bank's liaison suggested that retail sales picked up in September and motor vehicle sales to households rebounded in August. In addition, measures of consumer sentiment had increased to be clearly above average levels."

“Picked up”, “rebounded” and “clearly above average”. These are not the words that suggest the already super-easy monetary policy settings are about to be made easier. This is the critical take-away from the minutes of the October board meeting that the Reserve Bank released yesterday.

The minutes also noted that “dwelling construction remained higher than a year earlier and forward-looking indicators pointed to a further recovery in the second half of 2013”. In other words, get set for a housing construction surge.

While much of the focus of the markets was on the Reserve Bank leaving the door ajar for a further possible interest rate cut in the distant future if circumstances permit, the minutes were littered with a range of positive views on the domestic economy and the move away from mining investment and towards exports, household spending and construction.

It is hard to know why the central bank’s public comments are erring on the side of dovishness when the run of economic news has been clearly tilting higher. Perhaps it is the Bank’s wariness over the political ructions in the US and an assessment that the fall in mining investment domestically will be severe. Time will tell and in the case of US risks, it is fair enough that the Reserve Bank is apprehensive about moving to a tightening bias before that mess is sorted out.

A reasonably upbeat view on the economy, including the run of recent news, has been impressive to the point where the trajectory for a lift in GDP growth to around 3.75 per cent in 2014 is on the cards. While most forecasters would rubbish such an upbeat view, 3.75 per cent GDP growth in 2014 is within the upper bound of the RBA forecasts.

Think about it.

Low interest rates are fuelling a housing pick up, while retail spending is ticking higher. At the same time, export volumes are rising aided by the lower Australian dollar and the move from investment to output in many mining projects. Rounding out the positive news for GDP growth is the change in fiscal policy from what was the most restrictive single year in budget policy ever seen in 2012-13 to a point where some growth in government demand is likely in the year ahead.

If these drivers of economic growth align as I expect, bottom line GDP growth in 2014 should be close to 4 per cent and with that, the unemployment rate will be 5.5 per cent or less and inflation will be ticking higher, probably into the upper portion of the Reserve Bank's 2 to 3 per cent target band.

Of course, a market and economic meltdown in the US would change that scenario. Australia would not be immune from the world’s largest economy defaulting on its debt and sliding back into recession.

Even the recent local unemployment data, which confirmed the unemployment rate at a highly respectable 5.6 per cent, bodes well for confidence, spending and new economic activity.

In the final paragraph of the minutes, the RBA noted “The Board's judgement was that, given the substantial degree of policy stimulus that had been imparted, it would be prudent to leave the cash rate at the existing low level while continuing to gauge the effects”.  In other words, the fuse has been lit to support growth and we are not sure how big the bang will be. Fair enough to wait and see the effect of this. A big bang and the Reserve Bank will need to hike rates a lot in the next couple of years. A fizzer and more cuts will of course have to be delivered.

While a rate cut cannot be ruled out, it would take a lot of things to go horribly wrong for the RBA to move rates lower. The odds heavily favour the next move in rates being up.