The Australian Economy April 2014.

RBA Cash Rate held at 2.50%

• The RBA continued to signal a “period of stability in interest rates”, suggesting that it intends to keep the cash rate on hold for some time.

• There was however, a touch less optimism in today’s Statement, reflecting slower growth in China and the rise in the Australian dollar over the past few months. Nonetheless, the commentary still hints that the RBA is expecting growth China’s growth to be in line with the government’s target of 7.5% this year.

• The RBA pointed out that the recent appreciation in the Australian dollar would reduce the impact of the exchange rate in helping to achieve “balanced growth”. The central bank also reiterated that “the exchange rate remains high by historical standards”.

• Despite the slightly less positive nuances this month, the RBA still seems confident that domestic growth will pick up and that the transition in growth drivers from mining investment to other sectors of the economy will occur. Additionally, a lower terms of trade and Federal Reserve tapering continue to point to a weaker Australian dollar, which would provide support to the domestic economy.

• The current long-held view that the RBA will be on hold for most of 2014, before beginning to raise the cash rate towards the end of the year remains.

St George Bank reviewed the RBA’s Statement on their decision and comments below.

RBA Statement: At its meeting today, the Board decided to leave the cash rate unchanged at 2.5 per cent. Growth in the global economy was a bit below trend in 2013, but there are reasonable prospects of a pick-up this year.

The United States economy, while affected by adverse weather, continues its expansion and the euro area has begun a recovery from recession, albeit a fragile one. Japan has recorded a significant pick-up in growth.

China's growth remains generally in line with policymakers' objectives, though it may have slowed a little in early 2014. Commodity prices have declined from their peaks but in historical terms remain high.

St George Bank thinks The RBA continues to see the outlook for the global economy as one of improvement. Its view on the US, Europe and Japan is very much unchanged from March. However, the RBA is recognizing the risks emerging from China. Despite the concerns over China’s shadow banking system, and emerging defaults in recent times, the RBA still sees the outlook for Chinese growth as positive and “in line with policy objectives”. This could imply that the RBA still expects China’s growth to meet its government’s 7.5% growth target this year.

RBA Statement: Financial conditions overall remain very accommodative. Long-term interest rates and most risk spreads remain low. Equity and credit markets are well placed to provide adequate funding, though for some emerging market countries conditions are considerably more challenging than they were a year ago.

St George Bank views the above paragraph asa carbon copy of comments from a month ago. While global bonds have been supported by safe-haven demand as a result of political instability between Russia and the West, tapering of the Fed’s asset purchase program and a gradual improvement in the US economy suggest to us that bond yields will again edge higher.

RBA Statement: In Australia, the economy grew at a below trend pace in 2013. Recent information suggests slightly firmer consumer demand over the summer and foreshadows a solid expansion in housing construction. Some indicators of business conditions and confidence have improved from a year ago and exports are rising. But at the same time, resources sector investment spending is set to decline significantly and, at this stage, signs of improvement in investment intentions in other sectors are only tentative, as firms wait for more evidence of improved conditions before committing to expansion plans. Public spending is scheduled to be subdued.

St George Bank believes there remains some caution about the transition in growth drivers of the Australian economy from mining investment to other sectors. The comments seem to suggest that the RBA is still expecting non-mining investment to improve despite “only tentative” investment intentions as firms are waiting for more evidence of improved conditions. The decline in resource project construction remains a downside risk to the outlook. On balance, we expect that low interest rates and a stronger global economy will support a pickup in growth this year.

RBA Statement: The demand for labour has remained weak and, as a result, the rate of unemployment has continued to edge higher. It will probably rise a little further in the near term. Growth in wages has declined noticeably. If domestic costs remain contained, some moderation in the growth of prices for non-traded goods could be expected over time, which should keep inflation consistent with the target, even with lower levels of the exchange rate.

St George Bank also expect s the unemployment rate to edge higher, and to peak sometime mid this year. However, leading indicators are providing a promising sign that the labour market will stabilise. Improvements in the labour market also tend to lag behind economic activity.

The RBA is continuing to rely on domestic price pressures easing in order for inflation to be consistent with its 2 to 3 per cent per annum target band over the medium-term.

RBA Statement: Monetary policy remains accommodative. Interest rates are very low and savers continue to look for higher returns in response to low rates on safe instruments. Credit growth is slowly picking up. Dwelling prices have increased significantly over the past year. The decline in the exchange rate from its highs a year ago will assist in achieving balanced growth in the economy, but less so than previously as a result of the rise over the past few months. The exchange rate remains high by historical standards.

St George Bank confirms thatLow interest rates are doing what they can to support the economy. There is growing evidence of risk-taking by investors, rising asset prices and a pickup, albeit gradual, in credit growth. The RBA has however, toned down some of its earlier optimism as a result of the Australian dollar strengthening in recent months. The RBA has reiterated that the “exchange rate remains high by Interesthistorical standards”.   

RBA Statement: Looking ahead, continued accommodative monetary policy should provide support to demand, and help growth to strengthen over time. Inflation is expected to be consistent with the 2–3 per cent target over the next two years.

St George agrees that despite below trend growth over 2013, and a further lift in the unemployment rate, the RBA remains relatively confident that low interest rates and the lower Australian dollar will result in stronger growth. We tend to agree.

RBA Statement: In the Board's judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.

St George sees nochange to the RBA’s outlook for interest rates as it continues to signal a “period of stability in interest rates”. We continue to expect the RBA will leave rates on hold for most of this year before looking to raise them before year’s end.

SOURCE: St George Bank

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The Minutes of the April RBA Board Meeting : Tuesday, 15 April 2014

Slow Ahead

• The minutes from the RBA’s April Board meeting were another chapter in the ‘slow ahead’ saga. The economy is growing. It is responding to lower interest rates. But the growth is slower than they, and we, might like.

• Global conditions are assisting Australian activity but global growth is not exactly robust.

• The hoped for lift in domestic activity flowing from the lower AUD is likely to be eroded by the recent strength of the currency. The Board noted the impact of a lift in New Zealand’s cash rate on the NZD. That’s a path that the RBA’s Board is unlikely to take in the near term.

• Housing was discussed by the Board mostly in terms of investment in new supply. Rising house prices were noted but we doubt they are the Board’s major concern.

• The RBA appears content that wage growth is modest but disappointed that business is still reluctant to invest. No signals were sent to suggest that the RBA has altered its thinking on inflation. It still expects inflation remain broadly on target.

• The minutes today leave us comfortable with our long-held view that the RBA will leave rates on hold for an extended period of time before starting to normalise policy later this year.

The minutes of the RBA’s Board meeting paint a balanced view of the global and domestic economies.

The picture painted is not  all rosy but nor is it all bleak. In their view, the US economy is growing and some figures may have been adversely affected by the severe weather. Domestic demand in Japan is firm and growth in China is likely to remain above 7.0%.

The Board noted that figures on labour demand in recent months may have been distorted by variations in the samples. The recent good news appears to have balanced out the weaker news of late last year. They, and we, still expect the unemployment rate to creep a little higher. Economic growth is simply too slow to generate the jobs required to cut the unemployment rate.

The most downbeat section of the minutes deals with business sentiment and business investment – or the lack of it. It is true that business sentiment and conditions are close to average but there is still reluctance by business to invest. A growth in business debt was noted, but with credit to business growing at just 2.4% that is almost clutching at straws.

The recent pick-up in the AUD appears to have disappointed the Board. A lower AUD would lift Australia’s international competitiveness and cushion the pain currently felt by many manufacturers. Having noted the experience of the NZD, following the Reserve Bank of New Zealand’s decision to lift its overnight cash rate, one gets the feeling that the RBA is not in a hurry to follow suit.

As per last month, the RBA Board is in ‘Slow Ahead. Steady as she goes’ mode. It will take marked variations from their expectations in order for the RBA to change course. We continue to expect that moves towards normalising the RBA cash rate will begin toward the end of the year.

SOURCE Hans Kunnen, Senior Economist

Consumer Price Index

Inflation Poses No Immediate Threat : Wednesday, 23 April 2014

The quarterly growth rates of headline and underlying inflation were relatively contained in the March quarter and close to our forecasts; headline inflation rose by 0.6% and the underlying measure by 0.5%.

The annual growth rate of these key measures edged higher in the March quarter, however, but remained inside the RBA’s 2-3% per annum target band. Headline inflation moved from 2.7% in the year to the December quarter 2013 to 2.9% in the year to the March quarter – the fastest pace in just over two years. Meanwhile, the annual pace of growth in underlying inflation shifted up from 2.6% to 2.7%, which is just under the RBA’s recent forecasts.

There were themes of convergence in today’s data. The annual pace of growth of tradables and non-tradables inflation moved closer together as did goods and services inflation. However, non-tradables inflation, a big influence on services prices, is still relatively high and sticky.

Tobacco, health and education were the most influential in pushing prices higher in the March quarter.

Today’s data does not suggest the RBA needs to re-introduce an easing bias nor does it suggest that the RBA has to raise rates in a rush.

So the RBA can stay on the sidelines with its neutral bias intact. However, with inflation in the upper band of the RBA’s target band for the second consecutive quarter, the door remains open for a rate hike late this year.

Headline inflation rose by 0.6% and underlying inflation (average of trimmed mean and weighted median measures) rose by 0.52% in the March quarter.

These are relatively benign outcomes for inflation. Indeed, the underlying inflation growth rate for the quarter was the slowest in one year. Both headline and underlying inflation were close to our expectations but were weaker outcomes than consensus expectations, of 0.8% and 0.7%, respectively in the quarter.

The annual growth rate of these key measures edged higher in the March quarter, however, but remained inside the RBA’s 2-3% per annum target band. The annual rate of headline inflation moved from 2.7% in the December quarter of last year to 2.9% in the March quarter – the fastest pace in just over two years. Meanwhile, the annual pace of growth in underlying inflation shifted up from 2.6% to 2.7%, which is just under the RBA’s recent forecasts contained in its Statement on Monetary Policy.

Domestic inflation pressures eased in the March quarter, but still growing quicker than what the slowing in wages growth in the economy suggests.

Structural forces are likely contributing to the stickiness of domestic inflation growth. These structural influences include the ageing of the population boosting a range of prices. Domestic or non-tradeable prices rose by 0.7% in the quarter, giving the annual rate room to step down from 3.7% to 3.1%. This annual rate is the lowest since December quarter 2009.

Tradable inflation grew by 0.4% in the March quarter, representing the fourth straight quarterly rise after a two-year period of weakness. The fall in the Australian dollar since April last year is responsible for the stronger imported-price pressures.

On a year ago, tradables inflation rose by 2.6%, the fastest in 2½ years and moving closer to the non-tradable inflation rate.

So domestic and tradables inflation converged further in the March quarter. Goods and services inflation are also converging. Goods inflation lifted by 0.6% in the March quarter, taking the annual rate to 2.7%; this annual pace is the quickest in 2½ years. Services inflation also rose by 0.6% in the quarter but the annual growth rate eased to the slowest in three years at 3.3%.

Seasonal influences were also in the list of top influences. Education lifted by 5.1% and added 19 percentage points, reflecting the increase in annual school fees that typically occurs during the March quarter.

Medical & hospital services (up 1.8% and adding 7 percentage points) and pharmaceutical products (up 6.1% and contributing 6 percentage points) were also key upward drivers in the quarter and reflected the cyclical reduction in the proportion of patients who qualify for subsidies under Medicare and PBS at the start of each year.

Tempering the rise in the CPI in the quarter were falls in the price of furniture (down 4.3% and detracting 6 percentage points) and the maintenance & repair of motor vehicles (off 3.3% and detracting 6 percentage points). Falls in travel & accommodation also helped dampen inflation in the quarter. Travel and accommodation typically record price declines in the March quarter and this quarter was no exception. Domestic and international travel each dropped 2.4% in the quarter, each subtracting 6 percentage points from overall CPI.

States Analysis:

Consumer prices are above 3% in the mining States and territories of Brisbane (3.1%), Perth (3.1%) and Darwin (3.6%).

The inflation rates in the other States and territories are in the top half of the RBA’s target band; it includes Adelaide (2.9%) and Sydney, Melbourne and Hobart at 2.8%. Canberra’s economy is easing and its annual inflation rate is the slowest in the country at 2.6%.

Outlook

The inflation data gives the RBA room to stay on the sidelines maintaining its neutral bias. Today’s data does not suggest the RBA needs to re-introduce an easing bias nor does it suggest that the RBA has to raise rates in a rush. However, with inflation in the upper band of the RBA’s target band for the second consecutive quarter, the door is still open for a rate hike late this year.

SOURCE: Besa Deda, Chief Economist St George Bank

COMMON ECONOMIC TERMS.

Each month I will explain an important economic term to make your understanding of economic reports easier. We will start with two fundamental economic terms.

Consumer Price Index

The Consumer Price Index (CPI) measures quarterly changes in the price of a 'basket' of goods and services which account for a high proportion of expenditure by the CPI population group (i.e. metropolitan households).

The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.

CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. This is because large rises in CPI during a short period of time typically denote periods of inflation and large drops in CPI during a short period of time usually mark periods of deflation.

A CPI can be used to index (i.e., adjust for the effect of inflation) the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values.

As well as covering a wide range of goods and services the CPI measures price movements in each of the capital cities in Australia. The CPI provides the official measure of inflation in Australia.