The Reserve Bank is comfortable with the state of the Australian economy. Prospects are for moderate growth and inflation in the middle of its target range. I expect this happy state of affairs will produce neither a rate hike nor a cut following today’s meeting of the board.
Indeed, there are two important bits of economic data for release later this week. Various experts have concluded that if this data is stronger than expected it may call into question the wisdom of the two rate cuts late last year. While I suggested rates should be kept on hold then, new employment data from Roy Morgan Research, discussed here last month, suggests that the labor market may be in far worse shape than official figures indicate. (See graph below.)
The fog surrounding the international scene has hardly lifted in the past month. US data continues to suggest continued gradual recovery there. Jobs data has generally exceeded pessimistic forecasts. The US housing markets are proving resilient, and the US Fed is keeping monetary policy set easy. Share prices have been rising, to a level that may presage another substantial correction. Whenever the Fed begins to remove the excessively easy policy there will be difficult markets.
The long, slow train wreck that is the Eurozone continues. The longer the crisis is prolonged the less likely is a fall into depression, although in Greece and Spain rates of unemployment in excess of 20 % with rates for juniors double that (at least) means a thoroughly nasty recession. It is uncertain if Greece has actually defaulted on its debt, but what is certain is that creditors will take a severe haircut. It must be expected that ‘short back and sides’ will be the fashion in several other eurozone nations before long.
The state of the Chinese remains the most puzzling enigma to this writer. There are many negative partial indicators, especially in the trade statistics, which have been falling sharply. One of the major ratings agencies last week said there is a 10 % chance of a ‘hard landing’ for the Chinese economy and a 25 % chance of a soft landing. A hard landing would do immense damage here, with falling GDP, double digit unemployment and a massive shake-out in house prices. Even a soft landing in China would create a local recession.
As the Rudd-Gillard-Swan governments have already spent the legacy of Messrs Howard and Costello, and incurred large budget deficits and rebuilt government debt, there is far less room for fiscal stimulus. And, in any case, Mr Swan has already repeatedly promised a return to a (tiny) surplus in 2012/13, with no caveats this writer could spot.
The Indian economy is also experiencing interesting times. The official rate of unemployment as published in The Economist is almost 10 %, while consumer price inflation was 8.9 % in 2011. Here too the official rate of unemployment does not count those who have given up trying to find a job and disguises a lot if hidden unemployment.
Australia’s official rate of unemployment fell in January 2012, to a miraculous 5.1 %. We know that this outcome is made up of massive growth of employment in mining offset by falls elsewhere, plus many people working less hours that they would prefer. The latest labor price data shows annual growth of 3.7 % with a 4.7 % trend increase in average ordinary time weekly earnings for full-time adults.
Retail sales remain depressed, while (also reflecting the mining boom) business fixed investment is booming. Business credit fell slightly in January, and showed only a 1.4 % rise in the year. Non-housing credit for persons fell slightly in January and by 1.3 % in the year. Housing credit rose by 0.5 % in January and by 5.3 % in the year to January. This supports positive anecdotes suggesting house prices may be stabilising or beginning again to rise.
No real surprises in all this, and we may have a clearer picture by the end of the week after the release of data for the national accounts for the December quarter of last year on Wednesday and February's unemployment rate on Thursday.
In summary, on average the economy is in reasonable shape and so monetary policy should be broadly neutral, as it is now. There is nothing much the Reserve Bank can do to offset the dysfunctional labor market that makes the real situation far worse than the picture provided by the more accurate broader measures, except perhaps to moderate the weight given to the ABS unemployment rate in its decision making. The higher than expected wage data will make the board feel vindicated at its decision not to cut the cash rate again in February.
There is nothing much the Reserve Bank can do to offset the ‘two speed economy’ issues; it would be totally absurd as well as useless to have high interest rates in the Pilbara and other areas of strong mining activity and low rates in the manufacturing heartland.
And the Reserve should welcome evidence of business deleveraging and household spending restraint. Although governor Stevens has broadly endorsed the government’s fiscal policy, Henry is prepared to bet that in reality he would prefer government spending had been less wasteful during reaction to the global crisis and that the budget was already in surplus.
A stronger budgetary position would have left more scope for stimulus if the USA and Europe were in more serious slumps than they are at present. A worse outcome than now expected could still occur, if for example Greece and then other Eurozone debt dominoes fell, taking Eurozone banks with them. There is also legitimate uncertainty about the state of the Chinese economy, and how much it will slow, taking commodity prices down with it.
This is no time for monetary policy heroics. Business and household confidence will best be served by a steady approach, well communicated. This is broadly the current situation with monetary policy, and Australia would be well served if the Gillard government adopted a similar approach.
Published today in The Australian.