Weekend Economist: Rate respite

As expected, the Reserve Bank Board decided to leave the cash rate unchanged at 2.50 per cent at its March meeting and maintained the ‘neutral’ outlook for policy that it instituted at the February meeting, the first of the year. The governor’s statement accompanying the decision closed with a repeat of the line in February’s decision that: “On present indications, the most prudent course is likely to be a period of stability in interest rates”. The remainder of the statement was also largely unchanged from the February meeting.

The wording around the Australian dollar was a little different though. In February we saw a notable shift in wording on the currency from December’s reference to an Australian dollar that was “uncomfortably high” to no assessment of the overall level at all, just that its recent decline, if sustained, would assist in rebalancing growth. In March, the February comment was retained but with the extra observation that the exchange rate “remains high by historical standards”. Implicit in this is a desire for a currency that is even lower, although the rhetoric is less forthright than December’s “discomfort”.

The commentary around inflation was pared back versus the February statement but likely due to little new information becoming available (last month’s decision came following the surprisingly strong Q4 CPI result). The RBA’s central view remains that if domestic costs remain contained – wages in particular – moderating non-tradables inflation should keep inflation on target even with a lower currency.

On growth, wording changes were minor and a mixture of positive and negative. The bank noted rising exports – ABS data released on the day of the meeting revealed that net exports made a sizeable 0.65 percentage points contribution to Q4 GDP growth – but also that signs of improvement in non-mining investment intentions were still only tentative and added that public spending is scheduled to be subdued. There were no changes in commentary on consumer demand (“slightly firmer”) and housing construction (“recent information ... foreshadows a solid expansion”) although the wording on dwelling prices was strengthened (“prices have increased significantly over the past year”).

January’s poor labour market report (unemployment rate rising to six per cent), declining consumer sentiment amid renewed job loss fears and the related string of corporate lay-off announcements did not rate a mention. More specific commentary on the labour market, that “demand for labour has remained weak and ... the rate of unemployment has continued to edge higher,” was unchanged from February and again made in relation to the outlook for wages growth and domestic costs. The labour market is clearly being seen as a lagging economic indicator of less importance for growth assessments – indeed the Governor’s comments to the House of Representatives Standing Committee three days after the board meeting were more explicit. He asserted that employment typically lagged fluctuations in output by one to two quarters.

We do not completely share this view and see recent labour market weakness as, in part, evidence that economic conditions remained weak in late 2013/early 2014. Moreover labour market conditions have direct impacts on incomes and attitudes towards risk that can mean they have both coincident and leading indicator properties. Our own survey data shows consumers’ job loss concerns remain extremely high, at levels that have inhibited financial decisions and spending behaviour in the past. The steady drumbeat of bad news out of trade-exposed sectors is no doubt reinforcing this, noting that the most recent reads on consumer sentiment pre-date announced job cuts from Toyota, Alcoa and Qantas. The March reading of Westpac-MI Consumer Sentiment will be released on Wednesday and it will presumably capture some of these evolving structural change dynamics. We will be particularly interested in the unemployment expectations index, which should be most sensitive to this sort of news backdrop.

The RBA's March meeting preceded the release of the Q4 GDP figures on Wednesday and January trade, retail sales and dwelling approvals figures. The broad picture from these releases was positive. The governor's testimony on Friday accordingly reflected some updates to the bank's views. With respect to housing construction, the governor went out of his way to highlight strength in his prepared remarks. "It is clear that dwelling investment activity will rise strongly over the period ahead. Over the past three months, approvals to build private dwellings numbered almost 50,000. That is an increase of about 27 per cent from the figures of a year earlier, and is the highest three-month total in the 30-year history of this series." Compare that to the "solid expansion" described in the statement on the Tuesday.

Although the Q4 GDP gain and mix was largely as expected, revisions to the quarterly profile now have consumer spending showing a slight pick-up in momentum over 2013 compared to the pronounced weakening previously reported for Q3. That came despite continued pressure on incomes: real household disposable income declined in Q4. With retail sales showing a stronger than expected 1.2 per cent rise in January, this momentum appears to have carried into 2014. Dwelling approvals also came in above expectations, moving to high historic levels. January data should always be treated with caution due to seasonal adjustment issues, but even allowing for this the picture is more upbeat than expected. Certainly the constraining forces around confidence and incomes do not at this stage appear to be impacting households.

We expect these issues to become more apparent through 2014. The RBA is clearly firmly on hold awaiting more information, around the inflation picture in particular. We retain our view that rates will remain unchanged over the first half of 2014, but with two further 25 basis points rate cuts in the second half. The ongoing downturn in mining; fiscal consolidation; a stubbornly high currency amidst a fall in the terms of trade combine with two important macro dynamics the bank is presently choosing to understate: the feedback on confidence and incomes from continued labour market weakness and ongoing caution amongst business and consumers.

Matthew Hassan is Senior Economist with Westpac.