Traditionally, the RBA has been a very decisive institution. If the case for a rate hike was slowly building, more often than not the RBA would raise rates at the next meeting rather than wait for overwhelming evidence that a rate hike was required.
As Glenn Stevens argued in 2006: “the ‘murder trial’ standard of proof is not the one we should apply in making monetary policy. By the time it is beyond reasonable doubt that something must be done, it is usually clear that something should already have been done – and, given the lags in policy’s effect, it probably should have been done some time ago. By delaying action, this approach would mean that action, when it comes, will almost certainly need to be more aggressive.”
Over the past year, however, this seems to have changed. For example, in October last year, the RBA signalled that a rate cut in November was likely as long as Q3 inflation data was benign. Similarly, in April 2012, the RBA conceded that growth was disappointingly weak but again wanted to wait for the inflation data before it eased monetary policy. In both cases, the RBA seemed to have decided that a rate cut was justified, but waited until it was beyond reasonable doubt before changing policy.
We have explained this behaviour by suggesting that the RBA is currently a reluctant rate cutter. That is, the RBA doesn’t necessarily think that the economy is going gangbusters, but that it thinks by keeping rates a little higher for a little longer, that it will encourage households to rebuild their balance sheets, encourage firms to improve productivity and maybe also keep a little more ammunition up its sleeve for the time — when mining investment unravels — that it will really need it.
But regardless of whether or not this can explain the RBA’s recent behaviour, the key question for investors is whether the RBA will again delay a rate cut until the November Board meeting or decisively ease policy at the October meeting. In our view, the odds now favour an October rate cut. So what has changed?
We don’t think the RBA will be panicking about the investment outlook, and suspect that they will still regard it as the backbone of growth for the next 12 months. But that said, the investment outlook is clearly worse than it was a couple of months ago. Fortescue announced that it was cutting its planned investment by 25% on the day of the RBA’s September Board meeting, and several mining services firms have also become much more cautious about the outlook. The RBA now places a lot of credence in its business liaison process, and those anecdotes must have been much more cautious over the last month. Thus, even if the central case for the RBA hasn’t changed, the balance of risks must have become much more skewed to the downside.
Glenn Stevens has also stressed that “the RBA is a very outward-looking organisation, in the sense that we pay close attention to the world economy and financial markets.” There have obviously been no shortage of international developments in the last month for the RBA staff to discuss in their morning meetings. And here the important distinction is between what the data have done and what policymakers have done.
From the data perspective, the clear concern is the deterioration in global PMIs. And while the RBA has suggested that it is completely relaxed about the current state of Chinese growth, the lack of any improvement (and the reluctance of Chinese policymakers to stimulate growth) must be starting to affect the RBA’s assessment of the balance of risks. In this respect it was interesting to see that the Australian Government’s commodity price forecaster, while cutting its iron ore price forecasts by 20%, nevertheless expects a recovery in prices in 2013 on the back of Chinese government stimulus.
The RBA also seems to becoming gradually more concerned about the disconnect between the resilience of the A$ and the decline in the key bulk commodity prices. Indeed, it is this combination of factors that has exposed the position of the mining companies and put their cashflow under pressure. By itself, the resilience of the A$ won’t trigger a rate cut, but in the context of weaker global demand and the actions of the Fed, we would argue that it certainly adds to the case for a rate cut.
Finally, the RBA will consider the actions of the US Fed and the ECB over the last month. We’ve argued that this is clearly a positive development for financial markets as it reduces some of the downside risks emanating from Europe. But while the actions of the ECB remove some downside risks, they haven’t improved the growth outlook for Europe. And while the Fed’s actions arguably improve the outlook for the US economy, we think that this mainly occurs via a weaker US$, and hence will come at the expense of those countries against which the US$ depreciates (or fails to appreciate). It is only if those economies (mainly in Asia and Latin America but also including Australia) ease their macro-policy settings that overall global growth will improve. Thus, we don’t think the aggressive policy actions of the Fed and ECB reduce the need for the RBA to ease policy.
In the good old days, if the unemployment rate was rising, there would be a good chance that the RBA would be cutting rates, and if unemployment wasn’t rising, the RBA wouldn’t ease policy. But again, this old rule of thumb has not worked over the past year. There are still few signs of problems in the official labour market data, as long as you ignore the fall in the participation rate. But incrementally, the RBA does seem to have become more concerned about the labour market, noting that “the number of unemployment benefit recipients had increased.” Indeed, the number of unemployment benefit recipients is up by about 8% over the past year.
But again, the anecdotal information might be more important here than the official data. Accompanying Fortescue’s decision to scale back its investment plans was a raft of job cuts. And together with several coal mines being closed down because they had become uneconomic, it appears that the mining sector may no longer be the biggest driver of employment growth. At the same time, there has been a lot of attention placed on job cuts by State governments as well.
Fiscal austerity at a State government level is likely to be further reinforced by additional Federal Government cutbacks. The same lower commodity prices that have cut mining company cash flows, will do the same thing to the Federal Government’s corporate tax receipts. And with the Government still vowing to offset any revenue shortfalls with further spending cuts in order to achieve a surplus in 2012-13, the only question is how severe the cuts will be.
Over the last 18 months, the RBA has been happy to concede that some parts of the Australian economy — retail, housing, manufacturing, tourism — may have been weak, but that this was the (inevitable) price to be paid for the wonderful boom in mining investment. The dramatic fall in commodity prices changes that story. Now the mining sector is not the rationale for the strong A$, but has become another one of its casualties. In this environment, the RBA doesn’t have the same luxury to sit back and wait for that extra bit of information before cutting interest rates that it did previously. The time for decisive action has returned.