The Experts
Investor signposts - week beginning 23 August 2009
A: If interest rates are too low, the risk is that this will encourage excessive spending and borrowing. If there is too much money chasing too few goods, then prices can rise too quickly (inflation). Excessive inflation creates a range of problems for the economy, such as damaging the ability of our companies to compete with importers.
A: That is a tough one. The Reserve Bank doesn’t want to keep interest rates too low, for too long, for some of the reasons mentioned above. But if it lifts rates too early, consumers and businesses may lose confidence and stop spending, investing and employing. It is a fine judgement. When the Reserve Bank believes that there are greater risks in leaving rates too low than in lifting them modestly, it will start the ball rolling. While we think rates could start rising in the New Year, we wouldn’t rule out the first move happening later this year.
A: The Reserve Bank has found over time that a cash rate around five to 5.5 per cent works best for an economy operating “normally”. That is, a cash rate around those levels allows the economy to grow without generating inflation. But it could be a bit different this time. If banks have to lift rates independently because of the higher cost of funding, then the Reserve Bank may be slower to lift cash rates.
Q: I read that interest rates could rise two percentage points by Christmas. Is that likely?
A: The short answer is, no. While the Reserve Bank Governor suggested that rates could rise by two percentage points, the process will occur gradually over time to prevent the economy slipping backwards. Modest rate hikes of a quarter of a percent (25 basis points) are likely to occur early in the tightening process. If the economy picks up too much steam then the Reserve Bank may decide on larger rate hikes.
A: If there was a new crisis, such as a major bank crash or fresh economic problems overseas then the Reserve Bank may delay rate hikes. The Reserve Bank will closely watch the job market, but it doesn’t need to wait for unemployment to peak before lifting rates.
Q: Will the Reserve Bank give some sign before lifting rates?
A: It already has. The Reserve Bank Governor calls it “open mouth operations” – effectively a softening up process. If consumers get the message that rates are likely to rise and trim spending, then the Reserve Bank may delay the process of lifting rates to more normal levels.
There is one stand out event in the coming week, namely the June quarter business investment figures, released on Thursday. Apart from that key indicator, it is a rather tame affair on the economic calendar with car sales data released on Monday and construction work figures released on Wednesday.
While the investment figures will hog the spotlight, the key question is whether the data will incorporate the recent improvement in business confidence and conditions. The survey is conducted over July and August but the sharp lift in confidence levels may not yet have translated to actual spending plans. There certainly is anecdotal evidence that companies are re-starting projects, but it is early days in the recovery process.
Overall, we expect that spending on equipment and buildings probably fell by around eight percent in the June quarter, restraining overall economic growth in the quarter. In terms of future spending, an estimate near $77 billion for the 2009/10 year would be considered a positive result. While a softer result would be discounted, interestingly a firmer result would be seized upon as further evidence of economic resilience, and add to rate hike speculation.
The car sales figures for July will be heavily influenced by the Government’s tax break for business. In June, companies spent up big on motor vehicles on the fear that the tax break wouldn’t be extended. So expect the pull-forward effect to translate to a drop in July sales. We expect that car sales fell by around six per cent in seasonally adjusted terms in July after rising by 5.7 per cent in June.
While a hefty drop in car sales is expected, it would only be the first fall in four months. And given that the government has extended the tax break, firm sales results can be expected over the remainder of 2009.
The construction work figures not only provide the residential building component of the GDP (economic growth) equation for the June quarter, it will also give a sense of the volume of work yet to be done. The only caveat – as for the investment data – is that companies will likely be adding to work levels in coming months given the sharp improvement in business conditions.
In the US, the economic calendar is much better stocked than in Australia. On Monday the Chicago MidWest survey is released. On Tuesday, data on consumer confidence is issued together with house prices and the Richmond Fed survey. On Wednesday, data on durable goods orders is released together with new home sales. The updated (preliminary) estimate of GDP (economic growth) for the June quarter is released on Thursday with personal income and spending figures issued on Friday.
US consumer confidence probably improved modestly in August with house prices lifting for the second straight month in June. Results in line with these expectations should be favourable for share markets. And while the US economy probably contracted at a 1.4 per cent annual rate in the June quarter, investors are already looking past these figures to growth in the September quarter.
Firmer results are also expected for durable goods orders, new home sales, personal income and personal spending, giving investors good reasons to be more confident about the economic picture.
The profit reporting season winds down over the coming week. So far, the results have been decidedly mixed with around a third of companies producing results above expectations, a third in line, and a third have fallen short of analyst expectations.
On Monday, Centrebet and Fairfax Media are expected to report earnings. On Tuesday, Aristocrat Leisure, Crown, Flight Centre, Foster’s, Suncorp Metway, Macquarie Airports and Mirvac are amongst those to report. It’s a big day for earnings on Wednesday with Asciano, Centro, ConnectEast, Consolidated Media, Goodman Fielder, Healthscope, Transfield, Transurban and Westfield slated to report. Ramsay Health Care, Toll Holdings, Virgin Blue and Woolworths are listed to report on Thursday with Caltex, Harvey Norman and Sonic Healthcare on Friday.
At the height of the global financial crisis woes in October last year, interbank lending rates soared. Lehman Brothers collapsed and banks became less confident about lending to each other. The three-month US dollar Libor rate hit highs of 4.82 per cent on October 10, up from levels around 2.80 per cent in mid September. The lofty rates didn’t last for long, but it has been a relatively drawn-out easing process. Still, the good news is that Libor rates hit record lows of just under 0.43 per cent late last week.
There will be little guidance for domestic rate settings over the coming week. While the capital expenditure figures will be closely watched, the improvement in business conditions has probably occurred too recently to be fully reflected in future spending plans.
The Aussie dollar is expected to remain in its comfortable range of US80-85 cents until the end of the year. The main risk is for a break-out on the upside as investors focus on Australia’s role as a global energy exporter.
Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Published: Monday, August 24, 2009
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