Is there a new speed limit for the economy? In the recent Statement on Monetary Policy, the Reserve Bank broadly left unchanged both its economic growth and inflation forecasts for the period out to 2012. On current figuring the Reserve Bank expects the economy to grow by 3.25% this year and 3.75% in 2011, before a further pick up to around 4% by the end of 2012.
The interesting point is that the Reserve Bank has generally assumed a speed limit for the economy of around 3.25%. That is, if growth exceeds 3.25%, inflation is more likely to accelerate, leading to higher interest rates.
Next year that speed limit will be exceeded by half a percentage point with 2012 growth around three-quarters of a percent above a level considered to be “normal”. With that degree of speeding you would expect that underlying inflation would also be accelerating, breaching the upper limit of the 2-3% target band.
But not so. Over 2011 the economy is assumed to expand by 3.75% but underlying inflation doesn’t budge.
In fact, inflation is only assumed to creep up to 3% in 2012 at a time when the economy is presumably headed to 4% growth.
So what gives? Well part of the answer is that the Reserve Bank assumes that the “cash rate moves broadly in line with market expectations.” While it is possible to gauge those views, it is important to note that they are reasonably well developed over the next few months, but are less robust over the next few years.
Still there are views on the cash rate over the next twelve months with the one year overnight indexed swap contract standing at 4.65%. And the 30-day interbank cash rate futures contact has an implied yield of 4.72% in October 2011. In other words financial market participants only expect one rate hike at most over the next year.
To get views over the entire 21/2 years of the forecast horizon requires a different focus – 90 day bank bill futures.
The December 2012 contract has an implied yield of 5.14%, around 40 basis points above the current physical yield for 90 day yields.
So the Reserve Bank is assuming that two rate hikes over a 21/2 year period will be sufficient to keep inflation in the target band. If that is the case, it gives the impression that the speed limit has been lifted. That is, the economy may now be able to grow at a 3.50-3.75% rate without leading to higher inflation. How the
Reserve Bank has come to this view is uncertain, but it would be consistent with either consistently higher population growth or productivity or a new view of the efficiency of the economy.
A quieter week is in prospect with the spotlight on the Reserve Bank and wage data. The Reserve Bank releases minutes from its August 3 Board meeting on Tuesday while the Reserve Bank Governor delivers a speech on the same day and the Deputy Governor fronts the lectern on Friday. In terms of wages, the wage price index is released on Wednesday with average weekly earnings on Thursday.
Before we get to the main events, the support act comes in the shape of car sales data to be released on Monday. Overall the headline result on sales appeared good with 82,376 motor vehicles purchased in July, up 8.3% on a year ago. But the seasonally adjusted results are unlikely to look as good and we suspect that sales fell by 4.5% in the month.
The fact of the matter is that the government tax break boosted car sales in late 2009/early 2010 and we are now in the ‘hangover phase’. But the good news is that the job market is healthy, interest rates are stable and car affordability is the best since the mid 1970s. So the car market may be down, but it’s not out.
Investors will no doubt scour for fresh insights into Reserve Bank thinking when the minutes of the latest Board meeting are released on Tuesday. But the Statement of Monetary Policy has probably provided all the necessary views and information that investors need for now.
Still, we can look forward to yet more from the Reserve Bank on Tuesday evening (8pm Sydney time) when the Reserve Bank Governor delivers a speech entitled, “The Role of Finance”. Deputy Governor Ric Battellino delivers a speech to a Queensland business audience on Friday morning.
The other key focus over the week will be the latest figures on wage trends. The wage data is backward looking, so we are unlikely to see much evidence of wage pressures. We tip a 0.9% lift in the wage index for the quarter and growth of around 3.1% for the year. When you consider that the Reserve Bank only really gets concerned when wages are growing above 4%, the data is unlikely to unsettle investors. On Thursday the average weekly earnings data will provide dollar estimates for wages with mining leading the way with annual wages above $100,000 a year. Imports data is also out the same day.
Turning to the US, the pivotal day for economic data is Tuesday with housing starts, producer prices and industrial production all slated for release. Housing starts are tipped to rise modestly by 2% after two months of declines. And industrial production is expected to have lifted by 0.5% in July after a tepid 0.1% lift in June. Both those indicators would give investors heart that the US economic recovery is still on track.
The producer price data provides a different focus – the issue of deflation or inflation. The core rate (excludes food and energy) is tipped to rise 0.1% and 1.3% over the year. A result in line with that expectation would mean that the issue stays unresolved – inflation still exists, but it remains very low.
The other indicators to watch over the week include the Empire State index and capital flows data on Monday.
And on Thursday the leading index is released together with the influential Philadelphia fed index. The leading index is tipped to rise 0.1% in July after a 0.2% fall in June.
There are a number of speeches scheduled by Federal Reserve presidents but the one to watch is on Thursday when St Louis president James Bullard takes to the lectern. Bullard recently warned about the risk of the US going down the ‘Japanese road’ of low growth and deflation.
The Australian earnings season is well and truly in focus in the coming week. On Monday, BlueScope Steel, Leighton Holdings, Lend Lease and Newcrest Mining are amongst those reporting. On Tuesday the line-up includes CFS Retail Property Trust, GWA International, OneSteel, Primary Health Care and UGL Limited.
On Wednesday, APN News & Media, Boral, CarSales.Com, CSL, ConnectEast, Skilled Group, SMS Management and Woodside Petroleum are amongst those reporting. On Thursday, AMP, ASX, Brambles, Downer EDI, Healthscope, PaperlinX, QBE and Wesfarmers are amongst those that are expected to report earnings results.
And on Friday, Billabong, Duet Group, Spark Infrastructure, Prime Media, Platinum Asset and Consolidated Media are expected to issue their results. ANZ also issues a trading update on Friday.
When investors revise their views on the global economy, the Aussie dollar and the Aussie sharemarket tend to move in lock step, and that’s what we saw this week.
Early on Monday the Aussie dollar was trading at US92 cents and talk of parity again emerged. But by Thursday the currency had retreated to just above US89 cents. Similarly the ASX 200 index peaked just below 4,600 points on Monday but by Thursday it had retreated to 4,400 points. Commodity prices have under-gone similar corrections – the sort of corrections we have seen time and again over 2010. Investors have regularly been getting too far ahead of themselves and have been forced to revise views. Still, when you look at 2010 as a whole, the impression is that markets have been marking time.
US and European economies are recovering, but it is clearly taking time. Many investors had been hoping for ‘V shaped’ recoveries like in Asia, but they tend to forget that the eye of the GFC storm was in the North Atlantic and the economies will take longer to heal.
Craig James is chief economist at CommSec.
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