The Reserve Bank board meets next week on March 5. We expect that the board will decide to hold rates steady at the meeting.
Until the release of the capex data for the December quarter we had expected that the board was likely to act on its indication in its February board minutes that: "The inflation outlook, as assessed at this meeting, would afford scope to ease policy further, should that be necessary to support demand".
We now expect that the next rate cut will be in June reaching the 2.75 per cent low point which we originally forecast back in May 2012.
The capex survey was always going to be a key indicator as to whether the Reserve Bank would be encouraged that its objective of rebalancing the economy towards non-mining investment, given the expected slowdown in mining investment, had been gaining some traction.
In that regard the results of the survey which was released at 1130 AEST on February 28 indicate that the outlook for investment in 2013/14 is encouraging for services although poor for manufacturing (the services industries represent around 80 per cent of non-mining capex in the survey).
The survey contains the fifth estimate of business investment plans for 2012/13 (previous estimates in February; May; August; and November 2012) and the first estimate for 2013/14. We use the survey to assess two key signals – the developments in investment plans over the previous year and prospects for growth in investment for both 2012/13 and 2013/14.
The development of investment plans gauges how investment confidence has evolved over the year. A direct comparison can be made between the first estimate for 2012/13 and the first estimate for 2013/14. In that regard we saw an 8 per cent fall in the first estimate of total investment plans between 2012/13 and 2013/14.
That fall is significant given that there have only been three years since the early 1990's recession that first estimate plans have fallen.(2009/10: -2.3 per cent; 2004/05: -2.6 per cent and 1999/2000: -15.6 per cent.)
The total fall was driven by an 11.5 per cent fall in mining; 23 per cent fall in manufacturing; and a 5 per cent increase in services.
The fall in mining follows an average increase of 47.5 per cent over the previous three years as the miners ramped up their investment plans.
The fall in manufacturing is the biggest fall we have seen since the survey began in 1987.
The rise in "services" (up 5 per cent) is extremely modest given that the Reserve Bank has cut rates by 175 basis points. Compare the first estimate boost to services in previous "rate cut" periods – 2008/09 (35 per cent) and 2000/01 (19.7 per cent) – much stronger responses in previous rate cut cycles.
The response of manufacturing to rate cuts is also quite different. In the previous cycles manufacturing plans were boosted by 17 per cent (2008/09) and 4.7 per cent (2000/01).
The overall disappointing comparison of first estimates is being driven by a much sharper than expected slowdown in investment through 2012/13. The 2013/14 first estimate reflects the lower than expected starting point due to the sharp slowdown in 2012/13. This slowdown through 2012/13 is indicated by the reduced growth rates of investment spending in 2012/13.
The fourth estimate print indicated growth in mining investment in 2012/13 of 18 per cent; manufacturing of negative 17 per cent; services of negative 3 per cent and positive 7 per cent for the total. The fifth estimate indicates growth of 9.5 per cent (mining); -29 per cent (manufacturing); and -4 per cent (services) for a 1 per cent increase in the total (down from 7 per cent).
All this is a fairly dismal story. Manufacturing plans have been decimated; mining is slowing much more quickly than expected just three months ago; and services have contracted despite aggressive interest rate cuts.
So, why do we believe that such a disappointing result would not trigger another immediate rate cut? Simply because the estimates of investment growth in 2013/14 look, superficially, quite encouraging.
Using realisation ratios (to take into account that first estimates are typically significantly understated in services) we assess that the first estimates for 2013/14 indicate growth in overall investment of 11 per cent with mining up 11 per cent; services up 12 per cent and manufacturing "only" down by 3 per cent.
This interpretation of the survey can indicate two important issues:
– overall investment is expected to be boosted solidly in 2013/14.
– mining investment will not contract in 2013/14, as had been
feared by commentators.
– services investment, which explains around 80 per cent of non-mining investment, is expected to increase by a solid 12 per cent in 2013/14.
This will be the broad take by the Reserve Bank, encouraging stable rates. But these conclusions are highly sensitive to the choice of realisation ratios.
Consider two examples:
– Our choice of realisation ratio for mining (5th estimate) is 0.85 (the three year average). If you choose the historical average for the full history of the survey (0.93) then the estimate for growth in mining is boosted to 19 per cent in 2012/13 and 2 per cent in 2013/14. That would imply a plateauing of mining in 2013/14 with investment most likely contracting through the second half of 2013/14. A substantial drag on growth in 2014/15 could therefore be expected. That profile for mining seems more reasonable than two consecutive years of around 10 per cent growth in 2012/13 and 2013/14 having come down from 75 per cent growth in 2011/12.
– the realisation ratio we have used for services for the first estimate is 1.448 – the 10 year average. The range over the 10 years is 1.28-1.58. This wide range signals risks around the estimate. For instance using a realisation ratio of 1.35 would see the growth in services drop to 5 per cent in 2013/14.
These uncertainties lead us to believe that there remains scope for lower rates. After all, the dismal part of the survey, for 2012/13, will be much more reliable, given it is using a fifth estimate. The positive aspect of the survey relies on a much less exact first estimate.
The analysis above indicates that there are still considerable concerns and confidence; employment; housing and credit developments will continue to impact the rate outlook.
We continue to expect a weakening labour market and an ongoing muted response to rate cuts in housing and confidence measures.
We are also disturbed by the dismal response of manufacturing in the survey – an employer of 10 per cent of Australia's workforce.
By pushing back the rate call to June (which will benefit from another capex survey) we are allowing more time for the Reserve Bank to assess these issues.
In the near term we expect that our forecast GDP growth rate for the December quarter, that will be released on March 6, will print 0.6 per cent.
Our estimate of the Reserve Bank's growth forecast for the fourth quarter, based on the statement on monetary policy, is 1.0 per cent. Such a growth "miss" can be expected to unnerve the bank somewhat. That soft growth picture is consistent with the slowing profile in 2012/13 as indicated in the capex survey.
We also expect that such are the uncertainties around the capex survey that the Governor, in his statement following the meeting, will retain wording like , "The inflation outlook, as assessed at this meeting, would afford scope to ease policy further, should that be necessary to support demand".
Bill Evans is Westpac's chief economist.