The Reserve Bank Board meets next week. There is no chance of a rate move and, I expect, little chance that the two key themes of recent statements by the governor will change.
These are: "On present indications the most prudent course is likely to be a period of stability in interest rates”; and “the Australian dollar remains above most estimates of its fundamental value.”
The RBA is still clearly frustrated by the level of the currency. True the Australian dollar has fallen – from US69.20c to 68.80c (–0.5 per cent) in trade-weighted index terms, and from US87c to US85.3c (–2 per cent) against the US dollar – but that is not enough to placate a central bank that a year ago saw Australian dollar 'fair value' at around US85c, especially when iron ore prices have fallen by around 40 per cent since that time.
The market is now giving a 50 per cent probability to a rate cut next year. That type of pricing always intrigues me. If the RBA had decided on such a u-turn on its stated policy it would only move if it expected that there would need to be a second cut. In other words if a commentator chose to forecast lower rates he would need to forecast at least two cuts – something that neither the market nor the dovish commentators have been prepared to do.
At the annual dinner of the Australian Business Economists on November 25, I, in a public question, reminded the RBA deputy governor Philip Lowe that at the corresponding event two years earlier he had opined, in the Q&A session, that monetary policy 'worked' all the way down to a cash rate of 1 per cent. He could not recall that comment but asserted that it was his view that even lower interest rates would assist the Australian economy. However Lowe also argued that the impact of moves would tend to become more muted the lower rates were pushed, with confidence reactions in particular likely to be less positive.
This view, which accords with my own, seems a little different to the opinion voiced by the governor in an earlier speech on November 18: “A high level of construction, maintained for a longer period of time, is vastly preferable to a very sharp boom and bust cycle. That alternative outcome might give us a higher peak in the near term, but then a slump in the housing sector at a time when the fall in mining investment is still occurring.” That scenario indicates that lower rates, while still being an effective stimulus, might create other problems for the economy given the more pronounced impact on the housing sector.
While there may be some uncertainty about the value and/or virtue of further stimulus for the housing market there is no doubt that the authorities are clearly keen to see a resurgence in non-mining investment.
That is why the ABS Private New Capital Expenditure (CAPEX) release, which printed on November 27, was so important. Of most interest was the outlook for investment in the services sector. The August release had implied that mining investment for 2014/15 was expected to contract by 21 per cent; manufacturing investment by 6.5 per cent; and services investment was expected to increase by 12 per cent.
The message from a well-respected survey that services investment was to increase by 12 per cent was, arguably, the most encouraging piece of evidence around the outlook for the transition of the economy from mining to non-mining led growth.
The fear though was that, given some recent evidence of a slowdown in commercial lending, the outlook might have been significantly downgraded between August and November.
In the event, the report remained encouraging. Services investment is still estimated to lift by a very solid 11 per cent while the expected contraction in mining was scaled back from -21 per cent to -17 per cent. Manufacturing investment expectations were cut from -6.5 per cent to -11 per cent although this sector only accounts for around 10 per cent of total investment in this survey (mining is 50 per cent, with services accounting for the remaining 40 per cent).
The CAPEX survey for services showed most of the expected growth in investment was in real estate and hiring ($2.3bn); finance ($1.1bn); construction ($0.8bn); wholesale & retail trade ($0.9bn); and business services ($0.5bn).
These are all labour intensive industries and point towards some potentially better news around the employment outlook.
This expected growth in services investment is not out of line with the realised growth rate over the year to the September quarter. It increased by 5.5 per cent in the September quarter to be 12 per cent up on a year ago. While overall investment is dominated by the sharp slowdown in mining investment, the services 'story' is clearly cause for some optimism.
The RBA might also be encouraged by the latest print on business credit growth. Business credit is reported to have increased by 0.7 per cent in October – the largest monthly increase in six years (with the exception of June this year, which was inflated by a one-off bridging finance deal). Business credit growth to October is now at 4.3 per cent up from 1.3 per cent the previous year.
The key for the authorities is ensuring a smooth rebalancing of growth momentum away from mining towards non-mining investment and consumer spending. In that regard the release of the national accounts for September will be important to assess whether we are seeing any arrest to the slowdown in consumer spending we experienced in the first half of 2014. We are not particularly hopeful that there will be much relief in September (we are forecasting a subdued 0.6 per cent gain) but other data releases this week around business investment and credit give some cause for guarded optimism.
Bill Evans is a chief economist at Westpac.