The Reserve Bank statement on monetary policy for February has shown only a modest change in the forecasts relative to the November statement.
The only real forecast changes were a reduction in the year-average growth forecast for 2012, from four per cent to 3.5 per cent, and the through the year forecast to June 2012, from four per cent to 3.5 per cent. We assess that the reason behind these changes was firstly, growth in the September quarter 2011 was forecast to be 1.2 per cent and has subsequently printed one per cent. For the December quarter 2011 we suspect that the bank expected growth of 1.2 per cent in November and has scaled that back to one per cent in this statement.
Our best estimate is that the growth forecasts for the March and June quarters in 2012 have been retained at 0.8 per cent. In contrast, Westpac expects the quarterly profile for GDP growth to be 0.7 per cent in the December quarter of 2011, 0.5 per cent for the March quarter and 0.6 per cent for the June quarter. Overall that profile indicates year-average growth in 2012 of three per cent and through the year growth to June 2012 of 2.8 per cent. In summary, the bank has moved its growth forecasts slightly towards our less optimistic profile, but still remains much more upbeat than we expect particularly for the first half of 2012.
With only slight changes to the forecast profile our interest is mainly in the bank's rhetoric, particularly in the overview and the economic outlook. In the economic outlook, when discussing risks the overwhelming emphasis is given to concerns about a sudden deterioration in European financial markets. The bank quite rightly points out that there has been significant progress made in settling these markets mainly because of the efforts of the European Central Bank. However, the key sentence is: "as in previous forecasts it also assumes that a disorderly outcome is avoided. This remains the major downside risk for the global economy".
Further: "as noted in the November statement the possibility of a sharp slowing in Europe and contagion to the rest of our trading partners remains the key downside risk to the Australian economy". The overview concludes by emphasising that policy was judged in February to be appropriate "for the moment" and from the perspective of the domestic economy, demand conditions would have to weaken materially to prompt a rate cut. Based on the risk profile emphasised in this statement a sudden adverse development in European financial markets would also prompt a likely policy response.
The bank's assessment of the domestic economy is that overall the economy is growing at trend, while admitting that non-mining sectors of the economy are growing below trend. "Growth in household spending is expected to remain moderate in the near term as softer labour market outcomes, concerns about developments abroad and declines in net wealth weigh on spending... employment growth is expected to remain fairly subdued in the first half of this year.”
The bank notes that in its liaison work firms are expressing caution about hiring. However, the best guide we are given to their view on the outlook for the labour market is that "the unemployment rate is expected to increase modestly" – stronger employment growth is expected later in the year. At Westpac we are concerned about the likely deterioration in the labour market associated with the two-speed economy and the bank points out that there is a risk of larger job shedding in some sectors. But this risk does not appear to be given much prominence in their thinking.
In discussing the prospects for the domestic economy there is a general admission that the bank is quite uncertain as to the relative impact of a booming mining sector and a high exchange rate. We would add the other key headwind for the economy being the cautious consumer which, combined with the high currency, is likely to lead to a more adverse employment outcome than seems to be implied by the bank's "modest increase in the unemployment rate". These risks in our view certainly justify moving policy into the stimulatory zone.
In this statement the bank assesses the current policy stance as being neutral allowing, from our perspective, plenty of scope to provide further stimulus without moving too far into the stimulatory zone.
The bank is generally comfortable with the inflation outlook although it does point out that the price index for non-tradeables is now up by 3.75 per cent over the year. Some further moderation is likely to be required for overall inflation to be consistent with the midpoint of the target range once the effect of the appreciation of the exchange rate on tradeables prices fades.
The language around the domestic economy, apart from the downbeat assessment of the employment outlook, is also quite restrained. Retail spending is described as subdued, housing remaining soft and the scaling back of public investment and weak building construction are all weighing on activity. Credit conditions are tight for commercial property and building construction overall remains subdued.
It appears that the objective of this statement is to emphasise that without a significant deterioration in global financial conditions policy should remain unchanged. When you assess the various pieces of the bank's description of the domestic economy – weak employment; rising unemployment rate; subdued retail spending; soft housing market; below trend growth outside mining; scaling back of public investment; building construction subdued; inflation to remain around the mid-point of the target range; policy at neutral, not stimulatory – we see a fairly clear case for policy to move into the stimulatory zone immediately.
Of course our forecasts, as contrasted with the bank's forecasts, clearly suggest that the qualitative descriptions provided in this statement are understating the need for a policy response.
It has been and remains our view that a further 50 basis points in policy easing can be justified immediately although our forecast is that this adjustment is likely to occur over a three to four month period. We find the use of the requirement that demand conditions need to weaken materially before a rate cut can be delivered overly conservative and expect that the bank's policy will change more rapidly than we assess is their current intention.
Consequently, at this stage we maintain our view that the next rate cut in this cycle can be expected in March to be followed by a move in May, but recognise that we are currently dealing with a central bank that, while acknowledging all the reasons policy needs to be stimulatory, appears to have no immediate intention to move.
Bill Evans is Westpac's chief economist.