WEEKEND ECONOMIST: Under pressure

The minutes of the Reserve Bank board's November meeting were published last Tuesday. They gave some encouragement that the board would decide to cut rates at its next meeting on December 4.

That encouragement stemmed from three key sources.

Firstly, the board used quite strong language around the policy outlook.

The key statement is: "members considered that further easing may be appropriate in the period ahead". Contrast that with the September minutes which preceded the October rate cut: "The current assessment of the inflation outlook continued to provide scope to adjust policy in response to any significant deterioration in the outlook for growth". The former statement seems less conditional and would appear to provide a stronger indication that a move is imminent.

Secondly, we saw a much more detailed assessment of the labour market and the outlook was not encouraging.

In the governor's statement accompanying the November decision the labour market is described as "having generally softened somewhat in recent months". The minutes are more forward-looking noting that leading indicators of labour demand had softened suggesting modest near term employment growth was likely. In fact employment growth is described as remaining "relatively modest over the course of the next year".

Finally, the minutes emphasise the uncertainty around the board's previously-stated plan to ensure a strengthening in dwelling and nonmining business investment.
The board notes there is uncertainty about the timing and magnitude of this pick-up and therefore "uncertainty about the overall pace of growth of demand in the economy over the forecast period".

Business surveys are assessed as indicating conditions were a little below their long run average level. Since the board meeting, the NAB monthly business survey (conducted before the RBA meeting) shows a further deterioration. Indicators of private non-residential investment are described as "relatively subdued".

In its November statement on monetary policy the bank released its growth forecasts for 2012; 2013 and 2014. It expects growth through 2013 and 2014 of around 3 per cent. In the Chart we demonstrate how that growth could be achieved given the constraint of a substantial 'swing' in the contribution to growth from mining investment.

We expect that the Bank's assessment of the contribution from mining investment is broadly in line with the chart with it contributing 2.4 per cent to growth in 2012; 0.6 per cent in 2013; and subtracting 1.4 per cent in 2014.

From the perspective of GDP the achievement of 3 per cent GDP growth in 2014 will be assisted by a turnaround in the contribution to growth from net exports from a drag of 0.25 per cent in 2013 to a contribution of 0.5 per cent in 2014 as imports of mining equipment slow and some projects begin production. However we only expect growth in gas exports to increase by 5 per cent in 2014 with the big lift of around 50 per cent occurring in 2015 as most projects begin production.

The forecasts indicate a solid recovery in nonmining business investment. Its contribution to growth in 2012 is expected to be -0.6 per cent, swinging to 0.3 per cent in 2013 and 1 per cent in 2014.

In addition the consumer spending/housing sectors are expected to increase their contributions to growth from 1.9 per cent in 2012 to 2.0 per cent and 2.2 per cent in 2013 and 2014 respectively. The contribution to the lift from the consumer/housing sectors is expected to be constrained by a number of factors.

Firstly, we do not expect to see a reduction in the savings rate. That will restrict consumer spending growth to the pace of growth of household incomes. In turn employment growth is expected to remain subdued while wages growth is slowing. Lower interest rates will assist disposable income growth at the margin but short of a most unlikely fiscal stimulus it is hard to see any substantial boost to household income growth.

We believe we have seen the early signs of an uplift in the housing sector through both prices and construction. But credit availability will be impacted by the banks' funding challenges and the absence of substantial 'non-bank' funding sources.

That outlook highlights the importance of the forecast lift in nonmining business investment. Deteriorating business confidence is a particularly disappointing signal in that regard. Achievement of a 'respectable' growth rate in 2014 of around 3 per cent (i.e. the RBA's current forecast) is expected to require a 1.6 per cent turnaround in the contribution of non-mining business investment between 2012 and 2014. That compares with a 0.2 per cent boost from the consumer/housing component.

Next week's capex report on investment intentions will contain the fourth estimate for 2012/13 with the first estimate for 2013/14 not being released until February 28th next year. The capex survey is expected to reveal that overall investment grew by a solid 3 per cent in the September quarter but that was dominated by mining investment. We expect weak non-mining components for both the September quarter and plans for 2012/13.

If, as we suspect, the Reserve Bank also sees non-mining investment as the key to maintaining trend growth through the mining slowdown, lower interest rates seem to be the preferred strategy.

Lower rates will take some pressure off the Australian dollar, which has been a formidable headwind for businesses. Lower rates will also further stimulate consumer/housing activity. If businesses see their expected sales improving as a result of a more buoyant household sector then they may be encouraged to raise investment and employment plans. But there will be lags. We are only just seeing some improvement in the housing/consumer sectors.

With the inflation constraint dormant and wage pressures easing the bank has scope to further push towards this satisfactory rebalancing of the economy.

Mindful of the lags, particularly around business investment, there seems to be no good reason for the bank to delay the cut by a further two months until February.



Bill Evans is the chief economist of Westpac