WEEKEND ECONOMIST: The luck runs on
The RBA governor has painted a sober, as distinct from sobering, picture of the Australian economy that sees trend growth, little external shock risk and a slightly overvalued dollar.
In his opening statement, the governor set out the RBA’s economic assessment. Naturally, the themes were along the lines of those outlined in the RBA’s quarterly Statement on Monetary Policy, published a fortnight ago.
In short, the RBA judges that the Australian economy has been growing close to trend over both the second half of 2011 and up to the middle of 2012. This allows for the likelihood of a more moderate expansion of real GDP in the June quarter than in the March quarter. Growth at around trend pace accords with the RBA’s expectations. Consistent with trend growth, the rate of unemployment remains essentially unchanged from this time last year.
On prices, core inflation has moderated to about 2 per cent and the RBA expects inflation to remain consistent with the target. The exchange rate appreciation has had a significant impact on prices for traded goods, but this dampening effect is starting to wane. This will require that the more moderate growth of domestic costs and prices that we have seen will need to continue in order for inflation to remain consistent with the target.
On the world economy, the governor emphasised both the risks and that the global slowing to date has "been of the more ordinary variety”. Growth for the world as a whole is close to its long-run average and the IMF forecast for world GDP growth of about 3.5 per cent for this year seems reasonable, although the risks seem weighted to the downside.
The governor’s discussion of the Australian economy looked ahead to the peak of resource investment within the next couple of years, as was outlined in the SoMP. The expectation is that growth will still be close to trend, albeit with a different composition (with exports, residential and non-residential construction starting to pick up).
Committee chair Julie Owens, a member of the government, opened the Q&A with four leading questions, each of which invited the governor to acknowledge that the Australian economy is performing reasonably well, notwithstanding suggestions to the contrary. Not surprisingly, the governor obliged, agreeing with the proposition of these questions. The governor continues to see the economy as a "glass half full” and referred to his most recent speech of July 24, "The Lucky Country”, where he put the case that Australia is relatively well placed to withstand perceived downside risks.
Other questions focused on the currency, the labour market and the mining boom. There were a few key take-outs on these issues. The governor judges the Australian dollar to be "a bit on the high side” but "not dramatically so”. In terms of the risks to the economy, the question was if the dollar was a "long way above” fair value and whether it was above fair value for a "long time”. The governor noted that the RBA has not intervened in the currency market and the tone of his comments could be interpreted as implying that, given current circumstances, there is no plan to do so. As for intervention by the Swiss National Bank, the governor noted the differences between Switzerland and Australia.
In an earlier question, on forecasting, the governor referred to the difficulty of predicting the impact of shocks to the economy. He cited the current strength of the Australian dollar despite declines of the terms of trade. With the dollar not playing its normal shock-absorber role, there are important implications for the economy. The governor suggested that it is not inconceivable that the Australian dollar could go higher (due to safe haven effects and generally high rates of return in Australia).
The RBA views the labour market not only in terms of national averages, but also sees the labour market as a "patchwork”. The RBA tracks the dispersion of the unemployment rate across regions. This shows that the labour market is currently not more of a patchwork than normal. The governor is surprised that dispersion is not bigger and noted that it could get bigger.
On the mining investment pipeline, the RBA’s view on the outlook has not changed in response to recent announcements. The RBA has long expected that the peak of the investment phase will be in the next couple of years and that mining investment as a share of GDP will reach around 9 per cent of GDP. The next phase will be the boost to mining output, the export upswing.
As for the Westpac view, we were not surprised by the governor’s comments. Moreover, there was no discernible market reaction to the testimony.
In our judgement, additional interest rate relief will be required to ensure robust growth of the Australian economy during 2013. We expect world growth to be sub-trend this year, forecasting a slowing to just 2.8 per cent.
The Australian labour market is likely to be soft over the remainder of this year, with the unemployment rate rising to a forecast 5.7 per cent. Structural change, reinforced by the current strength of the Australian dollar despite lower global commodity prices, tighter fiscal policy, both at the state level and federally, household sector deleveraging, and ongoing caution against the backdrop of global uncertainty are all weighing on job prospects.
Our central case forecast is for the RBA to reduce the cash rate to a low of 2.75 per cent by the first quarter of 2013, but with the next move not until the December quarter given the RBA’s current wait and see approach.
Bill Evans is Westpac's chief economist.