The market got some important encouragement from the RBA governor's speech this week. Despite his indicating that he expected that 'neutral' was around 5.25 per cent (the current rate) there were some indications that rates could go significantly lower.
We were surprised that the assessed neutral rate was 5.25 per cent. Our view is that its more like 4.5 per cent. We see neutral as considerably lower than the old 5.5 per cent to 6 per cent range due to the weaker links between monetary policy and private rates.
However, It was encouraging to see the governor note that, for those countries where monetary policy was struggling to impact on private borrowing rates, "... it may simply lead policy makers to lower overnight rates by more than usual".
While the RBA is getting some traction on household borrowing rates there is undeniable slippage. In September-October the RBA cut the overnight rate by 125bps and the prime variable mortgage rate was reduced by 122bps yet household borrowing rates were only down by 73bps.
That reflected: rising credit card rates; only modest falls in personal loan rates; the portion of mortgages on fixed rate terms; and the much more limited pass through of falls to non-prime rates. Non mortgage debt still represents about 15 per cent of total household debt and clearly rates on that debt have significantly lagged RBA rate cuts. Further, for the fall in the cash rate in November (75bps) the prime variable mortgage rate was only cut by 58–65bps.
We expect the RBA to cut by 75bps on December 2. If the prime variable mortgage rate cut is again smaller then the RBA cut then markets should appropriately further reduce their low point target for this cycle.
The governor was also encouraging on the rate outlook front by noting that those countries like Australia which have practised disciplined macro-economic policies have "the most scope to move in an expansionary direction".
Finally, he emphasised the importance of public spending in filling gaps created by a contraction in private spending, sending a clear message that the current environment is appropriate for a more aggressive easing in fiscal policy.
This stance is extremely welcome because an active approach to a stimulatory fiscal and monetary policy is embedded in Westpac's growth forecasts for the remainder of this year and 2009. We are just as concerned as the governor who warned about the negative impact on confidence of constant gloomy speculation including the possibility of a recession: "the biggest mistake we could make would be to talk ourselves into unnecessary economic weakness".
The governor probably remembers the last time Australia printed a negative number for GDP growth; the December quarter of 2000. That was a time when there was a substantial bring forward of housing activity prior to the introduction of the GST on July 1 with an associated downturn in the second half. The media pounced on the negative print and pronounced RECESSION. Accordingly the next read of Consumer Sentiment for March 2001 fell by a staggering 13.2 per cent.
Westpac's forecast for six month annualised growth in the second half of 2008 is 3.2 per cent, while growth through 2009 is forecast at 1.7 per cent. Individual quarters are: September 2008, 0.1 per cent; December 2008, 1.5 per cent; March 2009, –0.2 per cent; June 2009, 0.1 per cent; September 2009, 0.5 per cent; and December 2009, 0.8 per cent.
The bulge in December 2008 reflects our view that the bulk of spending associated with the $8.7 billion fiscal stimulus package will occur in the December month particularly given the timing (pre Christmas) of the hand out. A one off increase in consumer spending which we estimate at 2.2 per cent could not be matched in the March quarter and we expect a contraction of consumer spending of 0.3 per cent in the March quarter. With consumer spending representing around 60 per cent of GDP such a bulge in spending distorts the pattern of growth and certainly any messages with respect to the strength of the economy.
A more even distribution of the spending associated with the fiscal stimulus would send a different message although the trends in the economy would be broadly the same. There must also be legitimate questions as to whether the ABS will be able to measure the spending so close to the end of the quarter. A more even distribution of the stimulus spending would see a very different quarterly profile for GDP growth. Growth in the December quarter would be 0.9 per cent and in the March quarter 1 per cent
Under that more even distribution of growth a slippage into negative territory in the June quarter would comfortably avoid two consecutive quarters of negative growth and the dreaded recession tag. This illustrates the nonsense associated with speculation about a recession, i.e. when a slower pace of spending the one off payment is supposedly all that keeps the economy out of recession. Probably of more concern to the impact on public sentiment of the recession talk is the September quarter 2008. This quarter has passed but any slip into negative growth would fuel a new round of recession talk with a possible damaging impact on consumer sentiment as per March 2001.
We are currently forecasting growth of only 0.1 per cent – a sliver away from a negative. The disappointing 0.1 per cent increase in real retail sales for the quarter will have most forecasters very close to the negative estimate. We are still awaiting partial indicators of housing construction and business investment. Dwelling approvals point firmly in the direction of a negative for housing while a 10.1 per cent jump in investment in plant and equipment in the June quarter suggests this is unlikely to print positive. There may be some upside in our estimates for engineering and non residential construction but combined these activities are still only three quarters the size of plant and equipment investment.
Other GDP components do not provide much upside either. Despite a surge in nominal exports most of the growth in Q3 was in prices rather than volumes and we are expecting a zero contribution from net exports. Government spending was strong in the June quarter with the typical pattern pointing to more modest growth in the September quarter.
That leaves inventories. In the June quarter growth in inventories was the weakest in six quarters and inventory accumulation took 0.5ppts off GDP growth in the quarter. We are currently assuming no contribution to growth from inventories in the September quarter particularly since we expect that cautious retailers will have been very careful not to overstock. However the surprise weakness in retail sales may have led to some involuntary inventory accumulation. It would be deeply ironic if we escape gloomy recession headlines because retailers inadvertently overstocked.
Our overall growth profile is of weak consumer spending; modestly contracting business investment; a solid recovery in housing investment but delayed until the second half of 2009; and slow growth in exports. The numbers behind that profile indicate no two consecutive quarters of falling GDP but that is largely dependent on the distribution across quarters of the spending associated with the fiscal stimulus.
The biggest risk of a single negative quarter may be the quarter just passed when spending was still reflecting the tight monetary environment that prevailed before the 100bp rate cut in October. It is ironic that whether the economy can avoid a damaging round of recession headlines may depend on whether retailers miscalculated demand for their products.
Bill Evans is chief economist at Westpac
