As expected, the Reserve Bank board decided to leave the cash rate unchanged at 3 per cent at its April meeting. There were three areas of interest in the associated Statement from the Governor.
Firstly, whether the bank would retain its easing bias; secondly how the bank would assess the surprise jump of 71,000 new jobs in the February jobs report; and finally whether the developments in Cyprus would impact the thinking around global risks.
Despite considerable doubt in the markets the bank’s easing bias was confirmed with the inclusion of the line: “The inflation outlook, as assessed at present would afford scope to ease policy further, should that be necessary to support demand”.
The governor was silent on the issue of the jobs report. In March, he assessed that: “with the labour market softening somewhat and unemployment edging higher conditions are working to contain pressure on labour costs”. The April statement merely noted: “labour costs remain contained”. This suggests that the governor is not prepared to accept that the job report signals an improving market but he is also not prepared to publicly dismiss the number. He appears to have left the issue open until we see further evidence around the labour market.
We assess that at least 50 per cent of the February increase was due to sampling variability with a further boost coming from a sharp estimated increase in the working age population. Of course despite the huge jobs number the unemployment rate remained steady at 5.4 per cent – we retain our view that the unemployment rate is likely to steadily rise through 2013 – a critical factor in the interest rate outlook. The monthly employment report will be key to future interest rate moves.
Over the month the Reserve Bank would have some reason to be encouraged that its rate cuts are working whereas there were other reasons to be disappointed. The December quarter national accounts printed weak overall growth (0.6 per cent) with very soft consumer spending (up only 0.2 per cent) taking much gloss off a boost to housing investment (up 2.1 per cent). Business confidence remains weak whereas the consumer sentiment report for March showed a strong reading with a 2 per cent increase following a 7.7 per cent jump in February. House prices are now up by around 5 per cent from the low in May.
While the national accounts pointed to very soft consumer spending the retail sales report for February is pointing to a substantial lift in tempo in the beginning of 2013. On the release we reported:
"Retail sales rose 1.3 per cent in February with January's already strong 0.9 per cent gain revised up to a 1.2 per cent increase. That was much stronger than the market expectation of a 0.3 per cent rise."
"Sales are up 0.7 per cent over the three months to February versus the flat fourth quarter. Monthly sales are back on a solid 0.4 per cent monthly rising trend (a 4.3 per cent annual pace). The strong back-to-back monthly retail gains suggest the solid rally in consumer sentiment in early 2013 is flowing through to spending. Even with a pull-back in March, nominal sales will likely be up 1.5 per cent quarterly, or more for first quarter versus the 0.1 per cent gain in the fourth. That in turn points to a 1 per cent plus gain for retail volumes.
"Although retail is only 35 per cent of total spending, this clearly represents a material upside risk to our current forecast for consumption which has growth accelerating from 0.2 per cent in the fourth quarter to 0.6 per cent in the first."
Markets have responded surprisingly modestly. Due to some weakness in global markets overnight the adjustment to market pricing has been to merely retrace the price gains from overnight. Markets effectively still have around an 80 per cent probability of a last rate cut by year's end with around 40 per cent by mid year. We are impressed by this boost to the consumer but still remain concerned about the approach of business.
Business confidence is being driven by factors apart from just expected sales. The question is whether businesses – worried by overregulation; political uncertainty; overvalued currency; slowdown in mining and global uncertainties – will still respond to this lift in the consumer and move to expand employment and investment. Without that dynamic the Reserve Bank is unlikely to achieve its objective of boosting growth back to trend in 2014.
Negative signals around employment will also, eventually, unsettle the household sector. Sensibly, the market accepts that it may take time for this question to be settled – we see the logic in that approach and accept that our current forecast for a June rate cut warrants intense scrutiny. That process is underway.
Apart from the dynamics around business other factors that create difficulties for the bank to return growth to trend in 2014 without further policy support were pointed out in the Governor's Statement following the board decision. He noted that “the peak in resource investment is drawing close” and that “the exchange rate, which has risen recently, remains higher than might have been expected”.
On the international front, European decisions to 'bail in' uninsured depositors in Cyprus are likely to unnerve bank depositors right across the troubled south increasing the risks of a flight of savings from the south to the north. That development alone, complemented by evidence of a policy-induced slowdown in China and some 'wobbling' in the US data will keep the international issues to the fore in the bank's thinking.
In short, the retail sales release for February does strengthen the case that more time than we had previously expected will be required to assess risks around growth prospects in 2014. We accept the case for reviewing the timing of our final rate cut. However at this stage we cannot abandon our assessment of the need for further stimulus until we can confidently raise our current forecast of below trend growth of 2.5 per cent in 2014 to a trend figure of 3 to 3.25 per cent or above.
Bill Evans is Westpac's chief economist.