WEEKEND ECONOMIST: Capex marks the spot
The Reserve Bank's growth forecasts are now substantially below trend meaning this month's capex data will likely be the final key to understanding further monetary moves.
The table below sets out the growth forecasts from the November SoMP and the new forecasts for the February SoMP along with Westpac's own forecasts.
Points to note are:
1) Growth to December 2012 has been maintained at 3.5 per cent. Given that the first three quarters of 2012 are currently printing 2.4 per cent this implies an expectation that growth in the fourth quarter will be around 1 per cent for the quarter. With real retail sales printing only 0.1 per cent for the quarter and our estimate that net exports will contribute 0.4 percentage points this implied forecast appears to be quite optimistic. Westpac's own forecast for the fourth quarter is 0.6 per cent.
2) Growth through the year to December 2013 has been lowered 2.25 to 3.25 per cent (midpoint 2.75 per cent) to 2 to 3 per cent (midpoint 2.5 per cent). We broadly agree with that forecast while noting that the governor's assessment that growth is likely to be sub-trend seems certainly supported with trend growth generally being accepted to be 3 to 3.25 per cent.
3) Forecast growth to December 2014 is unchanged at 2.5 to 3.5 per cent. That compares with Westpac's forecast of 2.5 per cent. With the first major shock to growth from the downturn in the mining sector expected in 2014 it seems particularly optimistic that this around-trend growth can be achieved.
4) Forecast underlying inflation in the year to June 2013 has been reduced from 2.75 per cent to 2.5 per cent consistent with the reduction in the known number to December 2012 from 2.5 per cent to 2.25 per cent. The measured core inflation for this period is around that 2.25 per cent indicating that without the effect of the carbon price on core inflation these numbers would be even lower. For the year to 2013 and beyond the bank has maintained its practise of using a wide 2 to 3 per cent band.
Reasons given for the downward revision in growth for 2013 are around an earlier than previously expected peaking in mining investment; substantial fiscal consolidation; persistently high Australian dollar and, most importantly, little sign of a near term pick up in non-mining business investment.
With the fiscal and Australian dollar effects probably unchanged from November the key reasons behind this downward revision appear to be the investment outlook. This highlights the importance of the ABS Capital Expenditure survey which indicated quite subdued investment intentions along with the bank's ongoing liaison. It also emphasises the importance of the next Capex report which will print on February 28 since this report will include the first estimate of investment intentions, both mining and non-mining, for 2013-14. This will give the Bank a better indication of the likely growth profile for 2014.
Note that monetary policy over the course of 2013 will be heavily influenced by the 2014 growth outlook. Westpac's forecast for growth in 2014 at 2.5 per cent is at the bottom of the bank's 2.5 to 3.5 per cent range indicating that we expect further downward revisions in growth in 2014. Another year of growth running significantly below trend would surely signal to the bank that financial conditions need to be eased even further.
The statement is surprisingly balanced around the sharp jump in the iron ore price. It is noted that this adjustment is most likely due to a significant restocking by Chinese steel producers after a sharp draw-down in inventories over the second half of 2012. As a one-off response it is assumed that prices will decline in the medium term and this response is unlikely to spur an uplift in mining investment as miners remain focused on containing costs and still report difficulty in obtaining finance for some projects.
The outlook for the labour market is not buoyant. Employment growth is expected to pick up gradually (annual employment growth currently running at 0.9 per cent) but will remain below the pace of population growth (1.8 per cent). As such the unemployment rate is expected to continually drift higher over the forecast period. Unfortunately the bank does not provide point estimates for their unemployment forecasts. This soft outlook for labour demand is likely to be consistent with modest growth in wages with growth in the wage price index which is currently running at 3.7 per cent to slow to 3.25 per cent over the forecast period.
The high savings rate is expected to be sustained with consumption growth broadly in line with income growth. However, the assumptions around employment and wages growth point to fairly modest income growth and therefore a moderate consumption outlook. Residential construction is expected to gradually recover, particularly due to a favourable investment environment as interest rates remain low and rental yields rise. However, the bank does signal a note of caution around the lack of improvement in the demand for new detached houses. Risks around the international environment are assessed as more balanced mainly due to a more settled scene in Europe. However, as we also argue, recovery in economic activity is some way off and prospects for Europe remain fragile.
When we assessed the governor's statement we were encouraged that he pointed out that there was scope to further cut rates should demand conditions require it. In this statement the bank not only maintained this signal but also used another signal that "the stance of monetary policy remained appropriate for the time being". It is our experience that the use of the terms "scope" and "for the time being" both indicate that the bank remains quite open to further easing policy.
These forecasts are certainly not consistent with a central bank accepting that a desirable equilibrium has been reached. Forecasts that growth is likely to be around 0.5 to 0.75 per cent below trend and inflation at the middle of the band suggest that there is more work to be done in monetary policy.
In the near term the critical report will be the capex survey which, as discussed above, was the main motivation behind the decision to lower the growth forecast in November. If as we expect, the first measure of 2013-14 investment plans disappoint then the bank may have to reconsider its assumption that growth will return to 3 per cent in 2014 with a necessary further interest rate cut following.
Bill Evans is Westpac's chief economist.