Another volatile week in global financial markets, with Australian markets in particular struggling to make sense of seemingly conflicting leads. But the underlying themes in the economic data released this week remain the same.
The slump in consumer confidence to the lowest level since January 1992 grabbed the most attention. There is a close association between both the trend and the monthly movements in the consumer confidence survey and the TD-MI inflation gauge:
Consumer confidence reflects rather than drives economic conditions and it is inflation rather than the real economy that worries consumers most, with purchasing power as measured by the CPI declining at a rate in excess of one percent per quarter since the beginning of the year.
Consumer confidence has only a weak influence on retail trade, controlling for other factors, but it does have a relatively strong
association with housing finance commitments for owner-occupation. This week’s continued crash-dive in housing finance, to the lowest level since October 2004, was thus not entirely surprising. This points to further weakness in building approvals and tighter housing supply, contributing directly to CPI inflation via upward pressure on rents.
Further weakness in dwelling investment will of course subtract from demand and ease inflation pressures via the output gap, but this influence on inflation is indirect and relatively small.
The median consumers’ 12-month inflation expectation was steady at 5.9 per cent in July. If the median consumer shares the market’s pricing for the future path of the official cash rate, then the expected real cash rate is only 1.4 per cent, well below neutral. So long as the RBA keeps talking down the need for further tightening, markets will undermine the effective stance of policy by pricing in a lower expected path for the official interest rate.
June employment growth came in well above market expectations, and even our own above market forecast, at nearly 30,000 additional jobs over the month. At the same time, the unemployment rate fell to 4.2 per cent, only 0.3 percentage points above the 34-year low of 3.9 per cent set in February. Leading indicators of the labour market point to a moderation in employment growth, but much greater weakness will be required to be consistent with a moderation in inflation pressures and the onset of a new easing cycle.
This week also saw The Australian newspaper release details of documents obtained under Freedom of Information legislation, which showed Treasury Secretary Henry and RBA Governor Stevens in furious agreement that the government’s Reserve Bank (Enhanced Independence) Bill will preserve the status quo in relation to the composition of the RBA Board. The new arrangements allow the RBA and Treasury to determine who is eligible to sit on the RBA Board, further entrenching the de facto bureaucratic monopoly over monetary policy decision-making. The names of the worthy were withheld from the documents, just as the contributions of external Board members are suppressed from the minutes of RBA Board meetings.
The minutes of the RBA's July Board meeting are released Tuesday, but are likely to reaffirm the Board’s watching brief in relation to demand and price pressures. RBA Governor Stevens speaks on "Challenges for Economic Policy" on Wednesday, which may be more revealing. To his credit, Stevens has already put in more public appearances in 2008 than in all of 2007, a welcome break from past practice. Second-quarter trade prices are released Friday, with export prices seen surging 10.6 per cent quarter-on-quarter, reflecting recent increases in bulk commodity contract prices. Import prices are forecast to rise a more modest 1.5 per cent quarter-on-quarter.
In New Zealand, May retail trade Monday is forecast at 0.3 per cent month-on-month. The June quarter CPI Tuesday is forecast at 1.1 per cent quarter-on-quarter and 3.5 per cent year-on-year compared to the RBNZ's June Monetary Policy Statement projection of 1.4 per cent quarter-on-quarter and 3.8 per cent year-on-year.
Dr Stephen Kirchner is an independent financial market economist. His blog can be found at www.institutional-economics.com
WEEKEND ECONOMIST: Who killed consumer confidence?
This week's data highlighted the close relationship between inflation and consumer confidence. With upwards pressure on inflation set to continue, the dark mood won't lift soon.
Want access to our latest research and new buy ideas?
Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.Sign up for free