WEEKEND ECONOMIST: While you were sleeping

The market was confident that the RBA would leave rates unchanged at its May meeting, but the meeting minutes show that it was not a forgone conclusion.

While financial markets snoozed their way through the May RBA board meeting, we now know care of the meeting minutes, that the board "spent considerable time discussing the case for a further rise in the cash rate".

This was something the RBA failed to mention in the statement following the board meeting itself, or in the RBA’s May Statement on Monetary Policy, both of which struck a comparatively dovish note. The revelation served to shatter the market’s complacency on the prospects of further rate rises, a complacency born partly of the RBA’s lack of timely disclosure.

We are seeing a consistent pattern where the board minutes are used to convey information that was withheld from earlier RBA statements, and yet forms a critical part of the policy outlook. Markets expect the RBA to disclose its policy bias on a continuous basis, rather than the staggered disclosure we have seen in practice. As noted in this column previously, the RBA’s failures in relation to continuous disclosure of its policy bias undermine the effective stance of monetary policy, by causing financial markets to price in an easier forward policy stance than the RBA actually intends. If the RBA hikes rates again, it will be at least in some small part due to its past failure to condition market expectations.

The board minutes also noted that inflation in Australia was considerably worse than for the average of the G7 ex-Japan, which it attributed to "relatively stronger demand conditions prevailing in Australia in recent years". But one could equally say that this is due to excessive monetary accommodation of these conditions. Treasury Secretary Ken Henry noted in his speech at the Australian Business Economists function this week that inflation in Australia reflects not an adverse global supply shock, as the inflation capitulationists would have us believe, but a country-specific positive demand shock.

He argued that "there is no reason to think that it is the sort of shock that cannot be accommodated by the sensible implementation of our inflation targeting framework". Of course, such "accommodation" has been precisely the problem, a problem in which Henry is deeply implicated as an ex officio member of the RBA Board. While Henry meant his remarks as a defence of inflation targeting against the inflation capitulationists, it is the inflation target breach over which he presides that has done the most damage to support for inflation targeting.

This week’s limited economic data calendar added little new to the outlook. The May Westpac-Melbourne Institute consumer sentiment index rose 2.7 per cent to 89.8, off a 15-year low of 87.4 set in April following four straight months of declines. The index is down 27.6 per cent on May last year. The index has been out of step with fundamentals, reflecting over-wrought media reporting of interest rate rises and overseas economic conditions.

Once again, there was almost no reporting of that other survey of consumers, which asks them about their 12 month inflation expectations. Inflation expectations rose to 5.2 per cent in May from 4.3 per cent in April. The number of respondents expecting inflation to stay within the RBA’s 2-3 per cent target range fell for the fifth straight month to 9.5 per cent, the lowest since June 2000, the month before the introduction of the GST. Since the RBA makes no pretence about being able to meet its inflation target this year, there is no reason why the public should believe otherwise.

All else being equal, rising inflation expectations demand higher nominal official interest rates, if the expected real cash rate is not also to decline. However, this week also saw markets re-pricing expectations for the nominal official cash rate, which is now expected to see at least one more 25 basis points tightening before year-end. This in turn saw the spread between three and ten year bond futures invert to around 20 basis points, after having flirted with parity in March and April.

Next week the data calendar remains lights. First quarter private new capital expenditure is released Thursday, which we forecast at 4.4 per cent quarter-on-quarter after a 5.1 per cent quarter-on-quarter gain in the fourth quarter. April private sector credit is released Friday, forecast at 0.9 per cent month-on-month, a slight pick-up on the 0.8 per cent month-on-month result seen in March.

Across the Tasman, the New Zealand government’s 2008-09 Budget delivered a fiscal stimulus equal to a massive 2.3 per cent of GDP, largely due to long-awaited tax cuts. The operating balance is expected to remain in surplus over the projection period, but only just. Larger cash deficits will be financed by a $NZ900 million expansion in government debt issuance, so the tax cuts are partly debt financed. This has seen markets push out expectations for a new RBNZ easing cycle, with the tax cuts seen putting a floor under an economy widely expected to have shown a contraction in first quarter.

For their part, most economists still expect a new easing cycle to commence at the September Monetary Policy Statement in the wake of the budget. The willingness to use the surplus to boost the supply-side of the economy (although the government probably thinks of tax cuts as a demand-side boost as well) makes for a sharp contrast with the Australian government’s preoccupation with revenue hoarding.


Dr Stephen Kirchner is an independent financial market economist. His blog can be found at http://www.institutional-economics.com