Category Archives: Analysis

Why what happens in Washington matters in Canberra

Among the economic indicators Treasurer Scott Morrison needs to keep an eye on, the US labour market should be toward to the top of the list.

As the US Federal Reserve begins to gradually edge up its funds rate, Chair Janet Yellen has indicated the tightness of America’s market for workers will be an important factor in shaping the central bank’s thinking on how quickly to proceed with tightening monetary policy.

The state of the US labour market matters because as it gets tighter, so the bargaining power of workers is likely to increase and wages rise, helping force inflation up.

The higher inflation goes, the more the Federal Reserve will feel compelled to raise interest rates.

This matters for Australia because the higher official US interest rates rise, the greater the downward pressure on the Australian dollar (though this relationship should not be overstated).

As the Australian economy tries to establish sources of growth outside the boom-and-bust resources sector, a lower dollar helps by making exports and locally-made goods and services more competitive.

In the past year, the $A-$US exchange rate has slipped down more than 10 cents to 71.2 cents, a far cry from the above-parity levels reached earlier this decade, when massive mining investment was sucking in huge amounts of capital.

Given that the US unemployment rate has already dipped to 5 per cent, it might come as a surprise that the Federal Reserve has only just begun to increase interest rates.

But behind the headline number, data shows that many of the jobs created in the last few years have been casual or part-time. This suggests that there is considerably more slack in the labour market than a 5 per cent unemployment rate would ordinarily imply.

Recent soft income growth underlines the point. In the year to September, US wages grew by 3.66 per cent, virtually half the long-term average of 6.33 per cent.

This is being reflected in consumer spending – US retail sales grew by a modest 1.7 per cent in the year to November.

The Federal Reserve held off embarking on a tightening cycle until it was confident that the US recovery from the global financial crisis was well-established, so its decision earlier this week to raise interest rates, even by a meagre amount, is seen as a vote of confidence in the world’s largest economy.

As he contemplates the sea of red in the Commonwealth’s financial accounts, Scott Morrison can only hope that this is the case.

Despite his bizarre denialism on the matter, the Federal Government does indeed have a revenue problem. Collapsing commodity prices and soft income and corporate tax collections account for a lot of the deterioration in the Budget position.

And the government’s own forecasts suggest there is not going to be a quick turnaround. Earlier predictions that the economy would expand by 2.75 per cent this year have now been pared back to 2.5 per cent, and next year it is expected to grow by 2.75 per cent rather than 3.25 per cent.

Estimates of business investment, household spending, the terms of trade and private final demand have all been downgraded.

As Reserve Bank of Australia Governor Glenn Stevens observed last month, a rebalancing in the sources of growth is underway, but it is a little rockier than might have been hoped for.

With the economy poised between the drag caused by tumbling resources investment and support coming from a nascent recovery in non-mining activity – particularly services – now would seem a bad time to be adding to the weight on activity by cutting into government spending.

To his credit, Morrison has so far eschewed the sort of bloodletting Joe Hockey pursued in his first Budget.

But the cuts he has outlined – crackdowns on welfare ‘rorts’ and the axing and reduction of bulk billing incentives for pathology and diagnostic imaging services, in particular – make little economic sense.

Both sets of measures, collectively worth more than $2 billion, will mean consumers have less money to spend.

As the country’s experience through the GFC has shown, this is significant. Arguably the most effective measure taken by the Federal Government when the GFC hit in late 2008 was to deposit money directly into the bank accounts of millions.

While much of this money was saved, enough was spent to keep shop tills ticking over, shielding thousands of retail and services sector jobs.

This was especially the case among lower-income households, where a higher proportion of income has to be spent rather than saved.

The bulk of Morrison’s cuts will fall on just such households.

At a time when retailers and service providers are trying to find their feet after several years of lacklustre conditions, this is hardly helpful.

Such unhelpful tinkering by governments all too common.

Economists often lament that government interference prevents an economy’s ‘automatic stabilisers’ (floating currency, swings in tax collections and welfare payments) from working effectively, making a difficult situation far worse.

But it is totally unrealistic to expect governments in such situations to do nothing – after all, they have usually been elected on a platform to ‘do something’.

As Ross Gittens suggests, they could do much worse than to devote their energies into devising a path to surplus that kicks in once a recovery is established, and to work out how to better handle future prosperity.



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Economy stuck in second

Happy anniversary.
It is now a year since the Reserve Bank of Australia Board cut the official cash rate to a historically-low 2.5 per cent, in which time the economy has been flat out trying to hold its ground, let alone take off.
And, the RBA’s analysis suggests, that is unlikely to change any time soon.
In his brief statement announcement the outcome of the Board meeting, Reserve Bank Governor Glenn Stevens said he expected growth to be “a little below trend [around 3 per cent] over the year ahead”.
Put this together the RBA’s view that inflation will remain consistent with the central bank’s 2 to 3 per cent target in the next two years – even if the dollar goes lower – and it suggests interest rates are not going anywhere for quite some time.
But if the prospect of an extended period of very low interest rates has borrowers excited, the reasons why this is likely to be the case are much less reassuring.
Essentially, the RBA has too keep rates low because of economic weakness.
The list of negatives dragging on growth is long, while the index of positives is depressingly brief.
On the plus side, all that investment in new and bigger mines, rail and road links and ports is paying off, and the volume of commodity exports surged early this year. The downside is that the massive pipeline of mining investment has virtually run its course.
Consumers are an important source of growth, and here the picture is equally mixed. Low interest rates are working to encourage people to borrow to buy and build homes, and a strong expansion in housing construction is underway (and the overblown hype about a housing bubble has been shown yet again to be a furphy).
In another promising sign, firms outside the resources sector appear to be brushing off investment ideas, though most are to commit money to expansion plans as they weight for evidence of a sustained lift in demand.
And this is where the picture gets murky.
One of the reasons the RBA is comfortable holding interest rates so low is that wages are going nowhere. In the year to the March quarter, the Australian Bureau of Statistics’ wage price index grew around 2.7 per cent. Over the same period, the headline consumer price index climbed 3 per cent, and even underlying inflation grew more strongly. In essence, household income is slipping behind the rise in living costs.
That is not good news for retailers keen to bump up prices and margins, and it is not likely to get much better for a while.
In the current economic environment, where the unemployment rate sits at 6 per cent and, according to Glenn Stevens, is likely to stay there for “some time yet”, workers have limited bargaining power to push for a pay rise.
Add to this the blow to jobs, investment and confidence delivered by the Federal Budget – and compounded by the political uncertainty as to what will actually be passed by the Senate – and it is not an inspiring outlook.
No wonder that the RBA and the financial markets believe interest rates are not going anywhere for quite some time.

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Flat retail leaves rate cut door open

No wonder the Reserve Bank of Australia appears so comfortable with the inflation outlook.

When retail sales fail to grow in a quarter, and edge just 1.1 per cent higher in the course of a year, that tells you everything you need to know about the extent of consumer caution and a lack of pricing power among retailers.

For a central bank contemplating a cash rate cut to 2.5 per cent, the environment doesn’t get much more unthreatening than this.

And the RBA Board, when it meets tomorrow, will have to taker into account the market’s emphatic expectation that monetary policy will be eased.

But this rate cut will not be the political tonic that governments usually get from moves that make borrowing cheaper – this time around it is a potent sign of how soft conditions in the economy have become – and how much more work the RBA may yet have to do.

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Tobacco excise hike not a long-term budget fix

It will be no surprise if there is a fall in rates of smoking after the announcement of a 12.5 per cent hike in the tobacco excise over the next four years.

Put up the price of cigarettes enough and even hardened smokers may think twice about the cost of their habit.

Treasurer Chris Bowen has been eager to repeat Heart Foundation claims that tobacco consumption tumbled 11 per cent when the excise was raised 25 per cent in 2010.

Higher prices are likely to be part of the explanation for a steady and sustained fall in rates of smoking – from 34 per cent of adults in 1980 to 17 per cent in 2010.

All in all, the excise increase is laudable as a public health measure.

But lets not kid ourselves that this is why the Government has taken the political gamble of jacking up the cost of smokes in the shadow of a federal election.

Any smokers who are encouraged to give up the habit, or any kids deterred from lighting up in the first place, is merely a happy by-product.

The Government’s real motive for the excise increase is to help plug the gaping hole in its revenue bucket.

According to the Treasurer, the change will net the Commonwealth an extra $5.3 billion over the next four financial years.

It is a hefty sum, but still well short of what the Government needs.

Bowen is expected to reveal tomorrow (August 2) there has been a $20 billion revenue write-down over the forward estimates.

That is why there is plenty of speculation swirling about what else might be cut, delayed or rejigged in order to staunch the haemorrhaging budget.

But back to the tobacco excise.

Two concerns immediately spring to mind – the credibility of the $5.3 billion revenue estimate, and reliance on excise revenue from a declining activity to help cover recurrent costs.

On the credibility issue, it is vital to know what assumptions Treasury has made in arriving at its estimate, particularly whether it factored in a decline in smoking rates and, if so, to what extent.

As mentioned earlier, the popularity of smoking has been in long-term decline.

Other assumptions Treasury may have made about smoker behaviour could also have important implications for revenue, such as the propensity to swap to cheaper brands as prices rise, or what might happen to the trade in illicit tobacco.

On the second concern, the Government could be setting up the budget for further trouble if it relies on the increased tobacco excise as part of a long-term financial fix.

Its own public health policies are aimed at the continued decline and eventual elimination of smoking.

This would certainly deliver big savings to the health budget in fewer cancers and less chronic disease, and would likely deliver a boost productivity because of fewer work days lost to illness.

If the proportion of smokers does indeed continue to decline, the only way to maintain the revenue stream will be to raise the excise even higher, encouraging even more to give up the habit.

It is similar to the problem created by trying to use a temporary burst of revenue (like a once-in-a-century surge in the terms of trade) to pay for massive ongoing personal income tax cuts (hello Peter Costello, hello Wayne Swan).

Smoking is very unlikely to die out (pardon the pun) as quickly as the commodity price boom, and tobacco excise revenue will probably continue to flow for many years to come.

But whoever is Treasurer in 2030 may find it is not the quick fix to a budget hole it once was…


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Kevin or Tony, business grinds on regardless

At about this point before every federal election, someone comes out and complain that political uncertainty is undermining business confidence and hurting investment.

True to form, business leaders were reported by The Australian earlier this week crying that doubts over when the election would be held were “sabotaging jobs and investment”.

We are led to believe that right now across the country, company boards, HR managers and purchasing departments are in a fit of angst about the current state of political flux, delaying crucial hiring and investment decisions as they wait on the Prime Minister to make the short drive to Government House to call the nation to the polls.

If this is the case, it must be an excruciating time for job seekers, merchant bankers, car salesmen and just about anyone else with something to sell.

It would mean that every three years or so – whenever an election looms – economic activity is brought to a virtual standstill as the nation awaits the verdict.

Problem is that, as with much received wisdom, it doesn’t stand up to much scrutiny.

Even a cursory inspection of official investment and employment figures suggests little correlation between election timing and swings in activity.

For instance, in the months leading up to the November 2001 election, private capital expenditure was regaining its momentum after having been savaged by the tech wreck. By the end of the year it had reached annual growth rate of almost 5 per cent – a 10 percentage point turnaround from the March quarter.

And again, in 2004, capex growth slowed in the three months to June to an annual rate of 2.5 per cent before accelerating sharply in the second half of the year to reach above 12 per cent in the December quarter – right when the election was held.

Of course, it has not all been one-way traffic.

Business investment was on a prolonged slide in the months leading up to the March 1996 election, when the Keating Government was dumped in a landslide.

But even here, other factors seemed to be at play.

Quarterly investment growth actually bottomed out the previous June (when it virtually stalled), and strengthened in the six months leading into the election. Maybe it was just that business was confident a change of government was on the cards.

The labour market similarly provides little support for the theory.

Just take these two examples.

In lead-up to, and aftermath of, the fractious August 2010 election, uncertainty about who would form government, and on what terms, was at an all-time high.

But throughout this extremely unsettled period, covering March to October, an extra 180,000 jobs were created, and total employment grew 1.6 per cent.

In 2007, the unemployment rate hovered at or below 4.3 per cent for the six months leading up to the November election, and rose only marginally to 4.5 per cent at election time before quickly reverting to 4.3 per cent the following month.

This is not to say that elections and the prospect of a change of government have no effect on businesses and the investment and hiring decisions they make.

Obviously, if the Federal Government is one of your important customers or a major employer in your area, you could well have a lot riding on the outcome of the poll (though neither side looks likely to unshackle Commonwealth spending any time soon).

But equally obviously, for most employers and investors the election and a possible change of government is only one of a number of considerations, and probably not a major one.

In the ebb and flow of domestic and international commerce, whether it is Kevin or Tony is ultimately neither here nor there – despite what people may claim.


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Yes, you heard it right: RBA says embrace risk

It is not often that you hear a central banker urge people to take on risk.

But that was the unexpected pitch from Reserve Bank of Australia Governor Glenn Stevens yesterday as he pondered where growth would come from now that the mining investment boom has all but ended.

In an intriguing passage in his speech to the Anika Foundation in Sydney, Stevens made it clear that nervous savers were in the policy sights of the central bank.

He said that, in lowering interest rates, it had been the RBA’s intention to prod nervous savers into backing out of increasingly expensive safe havens and instead start searching for growth.

As the Governor put it, “One of the things we have been watching for as we have been reducing interest rates has been an indication of savers shifting portfolios towards some of the slightly more risky asset classes, as that is one of the expected and intended effects of monetary policy easing”.

So there you have it, an endorsement from the RBA to take on more risk.

Australia’s central bank, like many others around the world, has done much of the policy work to support growth as governments have concentrated on budget repair and businesses have shied away from debt.

In comments that have imparted fresh momentum to rate cut speculation, Stevens said there was no “serious impediment” to easing monetary policy from its already “very accommodative” setting of 2.75 per cent.

Following his remarks, markets put the odds of a cash rate cut to 2.5 per cent when the RBA Board meets next Tuesday at 94 per cent.

But by his own admission, the Governor is unsure this will be enough to bring about a vital turnaround in confidence.

“It is somewhat concerning that the business community’s confidence has been quite subdued in recent times,” Stevens said. “It would be good if there was a bit more confidence in the business community about the future. Unfortunately…there’s no such thing as a ‘confidence policy lever’.”

The dour mood of business has meant investment in the non-mining sector remains soft, raising the prospect that economic activity – already below average – will slip even lower as the investment phase of the mining boom peters out.

It has also meant that funds that might otherwise go into productive investments have instead been locked up in conservative low-growth but relatively secure assets.

As Stevens said, this has come at a cost to both investors and the economy: “With many investors wanting safety, the price of safety has risen”.

Flagging that more rate cuts may be on the cards, he warned the price would probably have to rise even higher to encourage more adventurous use of funds.

“It [the price] has to rise by enough to prompt at least some people to start to shift their portfolios in the direction of taking some more risk – by holding equities, physical assets and so on, though obviously we don’t want too much risk-taking,” he said.

When even a central banker is urging investors to take a few more chances, you know the flight to security has gone too far.

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Low inflation gives room for rate cut, but no trigger

The Reserve Bank of Australia has ample room to cut interest rates if needed following evidence that inflation was muted in the June quarter, but an August rate cut remains unlikely.

While the central bank appears in no rush to ease monetary policy from its already very-low 2.75 per cent, confirmation that headline inflation grew by just 0.4 per cent in the June quarter, pushing annual growth down by 0.1 of a percentage point to 2.4 per cent, suggests it could cut the cash rate further without immediately feeding a dangerous build-up in inflation.

But the Reserve Bank is likely to keep a wary eye on underlying price pressures, particularly as the weaker dollar means the cost of imports is set to grow more sharply.

Official figures show underlying inflation grew by 0.6 per cent in the June quarter, holding the annual rate steady at 2.4 per cent – just below the middle of the central bank’s 2 to 3 per cent target band.

The most significant price increases in the quarter were for hospitals and medical services (up 3.4 per cent), tobacco (3 per cent), furniture (4.8 per cent) and rents (1.1 per cent).

These were largely offset by falls in the cost of domestic tourism (down 4 per cent) and cheaper fuel (down 3 per cent).

There is nothing in the result that will surprise the RBA, which has said it expects inflation to remain “consistent with the target” for the foreseeable future.

The central bank is likely to closely monitor the evolution of inflation pressures from overseas following the rapid depreciation of the dollar since April.

This effect is yet to show up consistently in the official inflation numbers.

The average price of tradeable goods and services – which comprise about 40 per cent of the consumer price index – rose by just 0.3 per cent in the June quarter, while average inflation among non-tradeable products was 0.5 per cent, mainly due to the pick up in housing activity.

The extent to which the high dollar and fierce international competition has helped hold inflation down was underlined by figures showing tradeables inflation fell 0.7 per cent in the 12 months to June, compared with a 4.3 per cent rise in non-tradeable prices.

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