Monthly Archives: December 2013

Happy Christmas, and may all monetary policy movements be good ones

Hi
Thank you for subscribing to Outlier this year.
Though macroeconomy and turbulent are not often uttered in the same sentence, it is exciting when they are!
Here’s to an interesting (read, occasionally unsettling) 2014!
Looking forward to sharing ideas.
Outlier

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Dire MYEFO numbers just political theatre

The manner by which the Mid-Year Economic and Fiscal Outlook is being released – a speech by Treasurer Joe Hockey to the National Press Club – tells you all you need to know about what this document is really all about.
For many years now it has been apparent that the main significance of the major Government economic statements, the annual Budget and MYEFO, has been as set pieces of political theatre rather than anything much to do with running the economy.
The days of markets surging or tumbling on Budget forecasts for growth and spending are long gone.
In the hands of Treasurers who were able political operators (think Paul Keating and Peter Costello), Budgets were more about imagery than numbers.
Keating had his emblematic turns of phrase, like “this is the one [Budget] that brings home the bacon”. During the 2000s, Costello delivered a string of Budgets with “surprise” revenue upgrades (to the extent that Treasury’s forecasting abilities became the butt of jokes).
This is how Hockey’s performance today needs to be viewed.
When he bemoans the parlous state of Government finances bequeathed to him by Labor, take it as a piece of political theatre, rather than an unsentimental appraisal of the fiscal position.
As has been extensively telegraphed by the Government through a series of leaks, MYEFO is likely to show the Budget deficit has ballooned out to close to $50 billion – a massive deterioration from the $30.1 billion estimated in the Pre-Election Economic and Fiscal Outlook released in mid-August.
Has the world really become so much darker in the past four months? The short answer is no.
While all the publicity surrounding the departure of Holden and other high profile business problems may have you thinking otherwise, the evidence in fact suggests that things are improving.
Internationally, the US recovery appears to be strengthening, China shows no signs of falling into the hole that many feared, and the euro zone appears to be negotiating the (very) early stages of a recovery.
Domestically, low interest rates are boosting housing activity and the dollar is easing lower. Treasury is basing its gloomier outlook on several developments since PEFO. It says the pick-up in non-mining activity and housing activity is slower than it was expecting, while mining investment has fallen more sharply than anticipated. “As a consequence,” MYEFO says, “employment growth is expected to remain subdued, and wage growth is forecast to remain well below trend.” This in turn will mean households hold back on their spending, restraining growth. All quite plausible.

But as Treasury itself admits, “nominal GDP growth forecasts carry with them additional uncertainty. The 70 per cent confidence interval for average annual nominal GDP growth over the forecast period ranges from 2 per cent to 5 per cent”. That is a not-insignificant range.

The economy’s transition away from mining investment-led growth to other supports for activity remains hesitant, and the speed with which other sources of growth develop is uncertain. But there is evidence that consumers and businesses hare shedding the funk that has held back spending and investment (excepting resources) ever since the GFC.
But the political story line Hockey wants to outline begins with Australia under Labor being driven into the ground. Queue forbidding music, dark skies and storm-lashed seas.
Over coming years, the narrative will go, the storm clouds will gradually dissipate, and at some yet-to-be-determined point in the future (though possibly in the months before the next Federal election) the first rays of economic sunshine will pierce the gloom, and the Coalition will be able to assure voters is has the country on track.
It is all a piece of political alchemy.
The fact is, in recent weeks, Treasury will have presented Hockey with a range of forecasts for nominal GDP (and hence, revenue) that range from the optimistic to the pessimistic, depending on various scenarios regarding developments in international economic conditions, the exchange rate, commodity prices, the rate of slowdown in mining investment and the speed of improvement in activity in other parts of the economy.
For his political purposes, Hockey has plumped for the worst-case scenario of soft growth and weak revenue flows.
This is not to say that Treasury has ‘invented’ the numbers to suit the Government’s political agenda – the forecasts are plausible and justifiable.
But they are just part of a range of possible outcomes, as Treasury itself explains in Attachments A and B in Part 3 of MYEFO.

On page 57, Treasury publishes a chart (Chart 3.9) indicating that “there is notable uncertainty around receipt forecasts and that this uncertainty increases over the estimates period”. For 2013-14, the 70 per cent confidence interval is a range of $20 billion and, at 90 per cent confidence interval, it is $30 billion.

Treasury is similarly cautious about its forecasts for the underlying cash balance (Chart 3.11, p58). The 70 per cent confidence interval for its 2013-14 forecast is $25 billion, and at 90 per cent it is $40 billion.

What the Coalition is doing with the Treasury numbers is nothing new. In the same way, for several years in a row, Labor Budgets contained projections for growth and revenue (particularly earnings from the mining tax) that were much more optimistic than many thought probable, because they supported the-then Government’s political goal of achieving a surplus in a set period.
Don’t get me wrong – Government spending is a problem. But the Coalition so far is taking the same Magic Pudding approach to public finances as Labor.
The current game of deficit/surplus one-upmanship between the major political parties is tiresome and empty.
It will only mean something when there is recognition of the much more important issue (as Rob Burgess highlights in Business Spectator today) of the structural position of the Budget.
The Parliamentary Budget Office forecasts the Budget to be in structural deficit until at least 2016-17, and thought bubbles like the Coalition’s ‘Direct Action’ climate change policy and its over-the-top paid parental leave scheme suggest the Government has no more appetite to tackle the problem than Labor ever did.

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Growth numbers suggest Abbott should be careful in cutting

As the Abbott Government’s Commission of Audit hunts for spending cuts and bureaucratic flab, the latest national accounts might give it some pause for thought about how zealous it should be.

The figures show that public spending added a hefty 1.3 percentage points to growth in the September quarter – without this contribution the already decidedly-anaemic GDP numbers (up 0.6 per cent in the quarter, 2.3 per cent for 12 months) would have been much worse.

As the numbers make clear, this is a fragile time for the economy, with a hesitant transition underway from mining investment toward other sources of growth.

Housing activity is strengthening, but the lift in the household savings ratio to 11.1 per cent is a fair indicator that although consumer confidence is improving, people remain cautious. (No doubt the urge to save was heightened by the air of uncertainty that surrounds any federal election, but the tepid labour market is probably a more lasting influence).

There are undoubtedly savings to be had in public spending, but in the zeal to make cuts, the Government needs to keep in mind that the public sector is not just a cost centre – it purchases goods and services, and it employs people, giving them the wherewithal to make their own purchases.

Australia is a long, long way from southern Europe, geographically and economically, but the experience of countries like Greece and Spain show that ill-timed austerity can make things far worse.

  

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No more rate cuts, but no rush to tighten yet

Interest rates look set to head higher, but the RBA’s “considerable uncertainty” about the pace of recovery in much of the economy means the first rate hike of the cycle could be delayed until well into 2014.

In a widely-anticipated decision, the RBA Board has decided to hold the cash rate at 2.5 per cent – meaning it will have been at this historically low level for six months by the time of the Board’s next meeting on February 4.

There is clear evidence that low interest rates are having an effect.

The property market is strengthening (house prices have risen, building approvals are up 23 per cent from a year ago), company profits are growing (up almost 9 per cent in 12 months), shares are rising (up 20 per cent in the year to date), and retail sales are increasing at a sustained solid clip (three consecutive monthly increases of 0.5 per cent or greater).

And the central bank thinks there is more of such news to come.

As RBA Governor Glenn Stevens put it today, “The full effects of these decisions [to ease monetary policy] are still coming through, and will be for a while yet”.

This is coupled with tentative signs that activity in the non-mining parts of the economy is picking up.

Official capital expenditure data showed manufacturers and other businesses were gradually increasing their investment, and the latest report from credit reporting firm Dun & Bradstreet showed 10 per cent of firms intend to hire extra staff in the first quarter of 2014.

If this is accurate, and businesses act on their hiring intentions, the unemployment rate may not rise much higher.

In further promising news, the official GDP numbers for the September quarter, due out tomorrow, may also be a bit stronger than many have been predicting.

The Australian Bureau of Statistics threw in a surprise today with its report that the trade surplus surged more than 50 per cent in three months to almost $9 billion, adding around 0.7 of a percentage point to activity in the September quarter.

The RBA’s known unknowns: the dollar and non-mining activity

But the persistently strong dollar and the sputtering recovery in economic activity outside the mining sector are the two greatest areas of uncertainty for the Reserve Bank.

Continuing recent efforts to talk the currency down, Stevens said the dollar (which was trading at just below US91 cents following the RBA announcement) was “still uncomfortably high”.

He almost didn’t need to add that the high exchange rate will have to come down in order for the economy to achieve “balanced” growth.

On this front, the Governor admitted that expectations for an acceleration in activity outside the mining sector were subject to “considerable uncertainty”.

Market Economics managing director Stephen Koukoulas is one of the few who for some time now have been predicting rates to rise in 2014 – he tips in the first three months of next year.

But the strong dollar could make it hesitate.

Koukoulas, for one, thinks there is much more the RBA needs to do much more to get the currency down – jawboning alone has had little effect.

If he is right, look for big sell-offs of the currency in coming days.

 

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A good week for the RBA

Every now and then you have a week when things seem to go right – your baby son suddenly begins sleeping soundly and copiously, you get the perfect park at work – twice! – and your bank gets in touch to say it has made a $100 mistake in your favour, and lets you keep it (ok, so that last one never happens, it is just a dream).

The Reserve Bank of Australia has just had such a week.

When the RBA Board sits down tomorrow for its monthly monetary policy meeting, it will see little reason to move the official cash rate.

All the signs are that the economy is behaving in ways that it has anticipated, and that are broadly in keeping with its monetary policy stance.

Low interest rates appear to be working to encourage activity in non-mining parts of the economy, particularly housing, while the dollar is depreciating and worrying price pressures are yet to appear.

Though there was a slip in building approvals last month (down 1.8 per cent), much of this was due to the volatile apartments segment of the market, and annual growth remains a healthy 23.1 per cent.

Of course, holding interest rates at historically low levels for an extended period carries with it risk, and some have started to fret that a bubble in the housing market, particularly in Sydney, is developing.

But the overblown talk of an over-heating property market, never well-founded, looks increasingly silly. Sure, house prices have surged in the major cities – most notably Sydney and Melbourne – but there are at least three good reasons to dismiss talk of a bubble at this stage. Firstly, there are signs that the market in established housing is losing some of its heat and price growth is easing. Secondly, and perhaps most importantly, credit growth remains modest – borrowing for housing grew by 0.5 per cent in each of September and October to be up 5 per cent from a year earlier, which is hardly what could be described as “bubble-like”. Thirdly, the nation’s population is growing at a solid rate of around 1.8 per cent, and the easing dollar makes Australian property an increasingly attractive proposition for foreign investors.

There are also encouraging signs that manufacturers and other businesses are starting to pick up the pace of their investment – a development that is coming none too soon, given the rapid deceleration in mining investment.

Official figures show that in the September quarter, mining companies cut their spending on plant and equipment by 7.1 per cent (while expenditure on buildings and structures increased 5.6 per cent). In the same period, manufacturers spent an extra 3 per cent on plant and equipment, and increased funds for buildings by 1.5 per cent.

Any investment plans should be well supported by healthy balance sheets. The Australian Bureau of Statistics confirmed today that business profits grew almost 4 per cent in the September quarter and are up almost 9 per cent in the past year. In the same period, wages have grown 3.1 per cent.

While GDP figures out on Wednesday are likely to show the economy was just ticking over in the September quarter, evidence that non-mining activity is building should push consideration of more rate cuts further into the background.

Instead, the RBA Board may soon begin to consider the timing of a rate hike.

Though it is unlikely to make such a move tomorrow, the central bank will be heartened by the dollar’s slide in recent days. Governor Glenn Stevens made it clear again last week that he thought its sustained strength against the greenback has been increasingly difficult to justify.

Inflation and wages appear well contained for now, but the longer the cash rate is kept at 2.5 per cent, the greater the risk prices could accelerate, which would in turn increase pressure for wage hikes.

As ever for a central bank, the trick is in the timing. Push up rates too soon or too fast, and the dollar could rebound, but leave them low for too long and potentially destabilising price pressures could accumulate.

 

 

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