Next week the Reserve Bank is widely expected to lift interest rates. Interestingly if you go back just over a fortnight ago no major forecaster was expecting a rate increase in October, believing that the Reserve Bank would want to see the September quarter inflation figures first (released October 27). But that was before a widely respected economic journalist indicated that rates were likely to lift on October 5. Oh, the Reserve Bank Governor also delivered a speech and Reserve Bank Board minutes were released. But there was little new in either.
So what gives – why are rates poised to rise? (Note we say ‘poised to rise’ – a rate hike is by no means a certainty.) It all gets down to strategy. If the Reserve Bank was to wait, the September quarter inflation figures may actually be favourable. That would make it more difficult for the Reserve Bank to justify a rate hike.
Now I know there would be some rubbing of eyes at this point. Doesn’t the Reserve Bank want ‘good’ inflation data – that is underlying inflation between 2-3%? Clearly that is the whole point of monetary policy. Interest rates are set to ensure that inflation holds between 2-3% over an economic cycle. And if the goal is achieved, surely that means that rate settings are ‘right’ – that is, rates don’t need to rise or fall.
The problem with waiting for the next inflation figures is that this is effectively setting policy by looking backwards, not forwards. The Reserve Bank must always be forward looking. Policy settings that are put in place now affect future decisions on spending, investing and employing. The fundamental point is that the Reserve Bank believes that inflation is not going to fall further and has given hints that its previous forecasts are too optimistic. That is, to keep inflation in the target band it will have to lift rates, not leave them where they are.
Now, it’s important to remember that these are just forecasts. The next inflation figures may surprise – they may actually be lower than Reserve Bank estimates. If that’s the case, the Bank may leave rates alone in November and December. And clearly it will have further justification to leave rates alone if retail spending remains soft. Remember the July lift in sales was all due to spending at cafes and restaurants – appears hard to believe. Also loans to build homes have fallen for an unprecedented nine months. And then there is the strong Aussie dollar, serving to keep inflation low and reduce activity in exports, manufacturing and tourism.
At each meeting, Reserve Bank Board members always ask one fundamental question – of all the decisions that I could make, which would I regret the least. In light of what happened in 2008, Board members are worried about getting behind the curve, rather than lifting rates a tad too much. At the end of the day, the Reserve Bank has the call, and Aussies hope that it will get it right.
In a strange quirk of timing, the economic cupboard is stocked full of data releases in the coming week. Of course that leaves a hole in the middle part of the month, but that is an issue for the future.
On Monday, the Labour Day holiday is observed in NSW, the ACT and South Australia. But other centres are open, so there is no holiday from economic data. The TD Securities/Melbourne Institute inflation gauge is released on Monday together with the Advantage job advertisement index.
On Tuesday the Reserve Bank Board meets, retail trade, the ANZ job ad index and international trade data are released and the Australian Industry Group and Commonwealth Bank issue the Performance of Services index. On Wednesday the head of the Reserve Bank’s financial stability section, Luci Ellis, delivers a speech and tourism arrivals data is released. The monthly employment survey is released on Thursday while the Reserve Bank’s Deputy Governor, Ric Battellino, delivers a speech on Friday.
As noted above, we think the Reserve Bank will lift rates on Tuesday. While we don’t believe that the RBA should be lifting rates – the economy is softer than it assumes and inflationary pressures are contained – it has the call.
Of the economic data, most interest will be in retail trade and employment, despite the fact indicators are backward looking, especially employment. Actually the job advertisement data, inflation gauge and Performance of Services are probably more instructive, but all the indicators to be released over the week have their uses.
Retail trade probably rose by 0.3% in August after the surprise 0.7% gain in July. All of July’s increase came from spending at cafes and restaurants, so if there is a reversal in August it could lead to a far weaker overall result for retail spending than assumed.
A potential complication is also possible with the employment figures as election-related hiring of staff may have inflated the figures. Overall though the jobless rate is at a 19-month low of 5.12% and little change is expected on that result in September. Employment probably rose by 20,000.
Of the other data, another solid trade surplus of around $2.5 billion is expected for August.
In the US, the spotlight will again shine brightly on the non-farm payrolls (employment) data, released on Friday. Again, as we noted for the Australian employment data, this indicator is backward looking. Still, in the US, concerns about a ‘double dip’ recession centre on the health of the job market. So there is no escaping the focus. Still, the ADP employment index (Wednesday) and weekly jobless claims data (Thursday) must also be watched closely for the same reason.
Economists expect that private sector payrolls rose by 75,000 in September after the 67,000 increase in jobs in August. While the modest size of the job gains will be bemoaned, it is important to note that employment is actually lifting a lot earlier than in the post-2000 recession. The unemployment rate probably edged higher from 9.6% to 9.7% as discouraged workers start to look for work again.
Of the other data, factory orders and pending home sales are released on Monday. On Tuesday the ISM services index is issued and consumer credit figures are slated for Thursday. And wholesale inventories data is released on Friday although it will clearly take a back seat to non-farm payrolls.
Economists tip mixed results with factory orders down 0.3 per cent in August, the ISM services index up from 51.5 to 52.2, the ADP employment index up by 18,000 and consumer credit down US$3 billion.
The US earnings (profit reporting) season begins on Thursday. Alcoa traditionally kicks off the reporting season and again that is the case. However given the focus on financial, technology, retail and home building stocks, Alcoa’s result (7 cents per share expected) is hardly a bellwether for the US corporate sector as a whole. Alcoa will be followed by the likes of Intel, JP Morgan, Google and General Electric in the following week.
Domestically the focus again will be on the so-called “annual general meeting” season. A range of issues will dominate these meetings such as guidance on dividends and future earnings, information on how companies are tracking in the new financial year and executive remuneration issues.
As we noted last week, our currency strategists have changed their forecasts. This follows the broader re-assessment of our economic assumptions and changes in financial market pricing. It now appears that the US Federal Reserve won’t be in a position to lift rates until the second half of 2011. And the European Central Bank and Bank of England may stay on the sidelines for the entire year. At the same time China will expand at a near 9% annual rate and our Reserve Bank will tighten policy to keep the economy on the straight and narrow.
We now believe that the Aussie dollar will end the year at US97 cents and that it will lift further to US$1.02 by the end of March 2011. However the Aussie is expected to ease to US94 cents in September 2011 and US92 cents in December 2011 as the US Federal Reserve starts lifting rates from emergency levels. The Aussie is also tipped to lose some ground against Pound Sterling in late 2011 to around 57 pence. But with low interest rates likely to be necessary in the Euro zone for longer, the Aussie is expected to end 2011 near 75 Euro cents.
Craig James is chief economist at CommSec.
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