Now that we’ve got a better idea as to how these floods are affecting
things and having seen the Q4 CPI, it’s fair to conclude that the RBA won’t
be hiking rates in February, or March either. I don’t think a March rate
hike is a zero probability event though, but taking everything into
consideration, I think it more likely we’ll be seeing a rate hike in
April/May – most likely May with the odds of them waiting till 2H11 very
low in my opinion.
Think of what we know. The fact is, the global economy is growing at a
rapid clip. Indeed the IMF expects growth around 4.75% in both 2010 and
2011. When you consider that the average is around 3.5%, well that’s pretty
strong global growth, 2yrs running I might add. So while we spent much of
last year debating the strength of the globe– in the face of very strong
data – it’s certainly not reasonable to refute its strength now.
This is all important, it sets the stage for everything, because if you’re
a lonesome central bank worried about a once in a generation commodities
boom, and the RBA is, then global growth is kind of critical. Look around
the globe, what does one see? A not so subtle combination of strong growth
and exceptionally loose monetary policy, that’s what. The problem is, this
combination according to theory, history and logic, is inflationary – and,
as we now know, inflation is actually rising.
Naturally there are risks, of course there are. Concerns over sovereign
debt are still rife etc. Yet in the absence of those risks, which lets be
sensible are quite extreme events, what is going to stop the momentum? I
mean what is more likely, the collapse of Europe or China and renewed
global depression (not zero probability events obviously) or a somewhat
less dramatic outcome – ongoing economic recovery. Note that economic
policy around the world, is incredibly accommodative and if you think
austerity is going to change that you’re dead wrong. Austerity barely makes
a dent into the stimulus provided by the world’s major central banks.
Doves in the Australian market are content to overlook this and instead
suggest that as domestic CPI is within the band, that as consumer spending
is weak and that given housing indicators are sluggish, the RBA can afford
to hold rates steady. The picture some of these people try to paint is one
of a sickly economy that is struggling under the unbearable weight of high
interest rates – proved by the weaker run of data lately. For others, the
economy is fundamentally sound, yet consumers are cautious, and inflation
First up, the view that the economy is weak or struggling is just simply
wrong – absolutely far-fetched. For a start, interest rates aren’t
unbearably high. They’re barely restrictive in fact and indeed mortgage
rates are only slightly above average with business rates only a little
higher than that. Don’t forget that in 2007, a time when new home loans
rose by over 1% per month, when building approvals rose slightly more than
that and retail sales were pumping 0.6% per month – mortgage rates were a
good ½% higher. It is implausible that rates are, on an economy wide basis,
providing much of a burden.
I think analysts who adhere to this view are simply confused. Focussing on
one or two data releases (retail sales etc), out of context I might add,
and ignoring more reliable data (the unemployment rate and the national
The 2nd view which I think is more common, is however, just as dangerous.
Granted, some data has been bizarre, and recent CPI prints do support the
idea that there is no urgency in hiking rates. I can appreciate that and,
following the weaker than expected Q4 CPI concede that point.
My worry is that some of the data points used to justify the rates lower
for longer argument, are actually giving misleading signals and I think
there are sound reasons to question them.
I’ve talked at length about the monthly retail survey. I suspect that it is
highly unlikely sales volumes are as weak as suggested by this survey and
the retailers association. They are inconsistent with the national
accounts, with job’s growth even jobs growth in the retail sector which has
been robust. By the way, the AUD expanded by 14% in 2H10 and yet prices in
currency sensitive areas were down much less than that. So there is some
significant margin expansion going on here and margin expansion isn’t a
sign of a weak retailing environment.
As to the CPI data more broadly – well unquestionably, the headline and
core numbers produced by the ABS show inflation moderating. I don’t dispute
this. What I dispute is that this then means true underlying inflation, the
persistent underlying trends driving CPI have changed. As I mentioned on
the day (and some may remember many years ago) inflation in Australia is
skewed. It is largely driven by food (including booze and smokes), housing
(rents, house purchase, and utilities), health and education. Normally
about 80% of the gain over any time period is driven by these components,
noting that they account for around 50% of the basket of goods surveyed.
Throw in fuel, and around 90% of the increase in the CPI over time can be
explained by 55% of the CPI basket. On the downside are things that either
post modest-flat inflation anyways, or even deflation on a consistent
basis. The important thing to note is that the secular forces driving
prices higher remain and it is only the timing of some of quarterly swings
that have given the illusion of moderating inflation. In essence, we’ve
Now the reason these dovish views are dangerous, is because even if they
are accurate, they don’t change, well they shouldn’t change the policy
assessment – the arguments for higher rates.
Think about it. Let’s just assume the doves are correct. Well so what? If
consumers are being cautious it is a voluntary choice. Ok so they are
lifting savings now, but there is no compelling reason to expect this to
continue in the future, with strong employment and incomes. Key point being
it could all turn on a dime . Ditto CPI. Let’s assume it is moderating now
will that be the case in 6-12 months, especially with global growth and
The bottom line for the RBA is whether they can afford to sit around and
wait to see who is right. And that’s where we get down to an assessment of
risks. On which side would they rather err? Leaving rates lower for longer
and then being caught out when retailers discover that spending isn’t that
bad after all, or hiking rates gently again soon, only to find that
consumer saving rates continue to rise, housing remains sluggish and
consumers cautious? Put another way, with interest rates barely above
average are one or two rate hikes in 1H11 going to seriously derail things?
No of course not. But if they leave it too long they risk getting into a
panic later in the year or early next. It’s quite conceivable that we
could wake up in 2H11 with strong retail sales and CPI above the band, a
global economy that is booming amidst exceptionally loose monetary policy
globally and domestic rates only just above average.
Why risk it? It would be completely unnecessary and would risk
destabilising the economy. The path of least regret is for the RBA to
tighten and soon, this makes the most sense, regardless of the current
dataflow. Do it gently now, when the downside is so small, so as to avoid a
panic run later.
The interesting thing to note is that when I look around at the run
forecasts for 2011 and 12 I’m not seeing too many forecasting doom and
gloom – even from the doves. Back in November, before the surprise Q3 GDP
outcome, the RBA was forecasting GDP growth of 3.75%y/y to December 11 and
4%y/y to December 2012. We’ll find out how the RBA has changed that this
Friday when they release the February Statement on Monetary Policy. Me, I’m
still looking for GDP growth 3.75%y/y to December 2011 and some thing like
3.5% in December 2012 – noting that assumes a handful of rate hikes. The
problem is that domestic demand is likely to quite a bit stronger than that
– 4.7% to December 2011 and 4% to December 2012.For the calendar year 2011
I reckon growth will be about 3.2% and 3.6% in 2012. CPI, both headline and
core, will likely be back above the target band by the end of the year.
If the RBA can see sense, then I would think we can expect them to hike
again, perhaps as early as March, but more likely April/May, the key issue
being whether they think it necessary to wait for the CPI. For the reasons
outlined above, I would argue it is not necessary, assessing the relevant
risks, it should manifestly clear what the RBA needs to do.