The Reserve Bank has released its November Statement on Monetary Policy (SoMP).
The area which we follow most closely is the revisions to the Banks' forecasts. For November these showed a larger than expected downgrade in growth forecasts. In the August SoMP growth in year to June 2013 was forecast at 2.5-3.5 per cent and that was the same for all dates out to December 2014. That is now changed to 2.75 per cent to June 2013 and 2.25-3.25 per cent for December 2013 and June 2014 increasing back to 2.5 per cent-3.5 per cent for 2014 (December). There were comparable downward revisions to the year average forecasts. On the other hand the Bank did not revise down 2012 (December) keeping it at 3.5 per cent - that implies expectations of around 0.75 per cent per quarter for the September and December quarters.
Comparing December 2012 to June 2013 implies they are looking for average 0.6's for the March and June quarters in 2013 - down from forecast 0.75's in second half of 2012. The Bank attributes the reductions in growth forecasts to a revised view on the investment profile in the mining sector. This seems reasonable for the lower medium term forecasts but seems a little curious for the slowdown expected in the first half of 2013 when investment plans for projects already underway seem unlikely to be significantly affected. A potential explanation here is that the Bank is not convinced about much near term response from the non-mining sector to the accumulated rate cuts.
The revisions (except 2012) come as a mild surprise and are more dovish than we expected.
On the other hand the Reserve Bank has revised up its inflation forecasts for June 2013 from 2-3 per cent to 2.75 per cent. That looks like partly a mechanical adjustment for the higher than expected September quarter print but they have reverted back to 2-3 per cent for 2013 (December) and 2014 (December). In addition they do note that the deflationary benefits of the high AUD appear to be waning and productivity gains in the non-traded sector are likely to be necessary to contain inflation pressures. It is also noted that an expected moderation in wage inflation due to softer labour market conditions and as suggested by business surveys and the Bank's liaison has yet to be confirmed in the official data.
Overall the downward revisions to growth are larger and further out than we had expected so these forecasts overall must be described as 'dovish' confirming that they are open to further cuts.
As discussed the major theme running through the commentary is around the mining sector. The downward growth revisions are largely attributed to the revisions in mining investment and there is even some note made of recent information around LNG projects which have further supported the changes.
In discussing the growth forecasts for the non-mining sector there appears to be an upward revision of 0.25 ppts to the growth contributed from sectors such as consumption, non-mining investment and housing construction. Commentary points to a stabilisation of the housing sector. However, the Bank also
notes that survey measures and liaison indicate that non-mining investment remains subdued. Of course the forecasts continue to take into account fiscal consolidation although no change is implied from the recent MYEFO policies.
The Bank has further revised down its terms of trade forecast to a fall of 15 per cent from the September 2011 peak although they forecast a recovery in bulk commodity prices in the near term to be followed by a further easing as global supply picks up.
World growth forecasts have been revised down in line with the IMF's downward revisions and for 2013 are consistent with our own view of growth around 3.5 per cent. The view on China is balanced with growth now being described as having stabilised in response to an easing in financial conditions and fiscal policy. Consistent with previous statements the Bank still sees downside risks to the global economy driven by the unstable situation in Europe. It is also of the view that US growth is expected to remain moderate.
Overall the mining cycle is the theme which now dominates the Bank's thinking and is embedded in the downward revisions to the medium term growth outlook. The forecast slowdown in the mining sector reduces growth to mid 2014 from 3 per cent to 2.75 per cent. What we do not know is whether that growth pace is considered to be acceptable.
The impact of the bigger fall than previously forecast in the terms of trade which would directly impact nominal GDP should have been expected to take some growth off consumption and investment. It is not clear how those profiles have been woven into the new forecast. On face value it seems like there has been little change but the implied growth in the first half of 2013 of 2.5 per cent annualised seems soft and certainly does not seem consistent with a resurgent non-mining sector. We are also not given much insight into how these lower growth rates are expected to affect the labour market with the unemployment rate expected to rise a little further before employment growth picks up as growth in activity in more labour intensive sectors picks up.
Of course these forecasts, as with those in August, are predicated on an unchanged cash rate and an unchanged exchange rate. The exchange rate in August was around the current level while the cash rate was 3.5 per cent compared to the current 3.25 per cent.
Growth in 2013 has been revised down by 0.25 per cent while the Bank notes that the revisions to the mining investment profile will reduce growth by 0.5 per cent. That implies that the non mining sector is expected to contribute 0.25 ppts more to growth than was assumed in August. That results from a lower assumed cash rate and, presumably, some upgrades to the investment/housing/consumption contribution. However, short of some very tentative observations around housing stabilising there do not appear to be any other pieces of evidence to support that domestic growth upgrade view.
Overall there is no real change in the tone from the Governor's statement following the November Board meeting. The real insight from this statement is how the growth forecasts have changed as a result of a downward revision in the investment profile of the mining sector and a modest upward revision to non mining. Growth is now forecast to be a tepid 2.75 per cent in the year to June 2014.
What is not clear is whether the Bank is satisfied with that growth partly because the commentary around the labour market remains fairly vague. Over the next few weeks the Bank will receive information on the mining and non-mining investment profiles with the Capex report on November 29. It will also receive data on wages as a useful proxy for inflation pressures.
Despite the downward revision in overall growth there has been
no downward revision in inflation. The lower growth is seen to be offset by the higher starting point for the forecasts. Inflation is described as "close to half a percentage point higher than the rate of underlying inflation three months ago". This may also be partly explained by the upward revision to growth in the non mining sector (see above).
The state of the world economy will remain an issue and the level of the Australian dollar will be closely monitored. We believe that the case for further rate cuts is strong and today's report highlights the impact on growth of the Bank's changing view on the mining sector and its need to upgrade the contribution from the non mining sector to avoid a growth forecast of 2.5 per cent which surely would be seen to be inadequate.
It is our view that lower interest rates will be required to ensure that the non-mining sector plays its part in compensating for the more modest contribution from mining. The decision for December seems to be very much live. Evidence from wage pressures and the Capex survey will help cast light on the Bank's revised mining investment profile. It must be tempting for the Board to increase the chances of the uplift in growth from non mining by easing rates further.
The path of the AUD will also require close monitoring. While the current level of the AUD is incorporated into the forecast, there must be huge uncertainty around that effect. At any time the AUD could give the bank adequate reason to take some more insurance around ensuring its forecasts for non mining growth are realised -- note the comment that "the current level of the exchange rate could also have a more contractionary effect on output than anticipated".
We maintain our call for a December rate cut.
WEEKEND ECONOMIST: December doves
The downgrade in growth forecasts by the Reserve Bank suggest a rate cut in December is likely. Although inflation rose a tad over the quarter, the forecasts suggest the RBA is leaving room for a cut.
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