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Spotlight on the RBA's statement

David Bassanese
Wednesday, July 22, 2015

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There was some tentative good news in yesterday’s Reserve Bank of Australia’s minutes from the July policy meeting – in which official interest rates were again left on hold.

That said, it is still hard to be overly bullish for the economy and our share market unless the $A drops a lot lower fast. Indeed, I suspect the $A still needs to drop to around US65c before it starts to notably transform our trade competitiveness and help boost key service areas like tourism and education once more. At that exchange rate, even pockets of Australian manufacturing might start to look competitive again.

My long-held view (since February) has been that the $A would drop to US68c by year-end, and I see no reason to change that view. Of course, I had also been expecting the RBA to cut the official cash rate to 1.5%, but there’s a chance this might now take a little longer.

So what’s the good news in the RBA statement? For starters the Board reiterated my view that while Greece’s problems were bad news for Greece, it was not necessarily bad news for the rest of the world and Europe in particular.

Indeed, the Board noted that there had been few signs of financial market contagion through the rest of Europe during latest bout of Greek problems – unlike in 2012. And it noted “this was consistent with the economic and financial exposures to Greece – apart from the official sector's financial exposure – being quite low.”

The lack of contagion risk is why the rest of Europe felt able to take a hard line in negotiations with Greece – Europe essentially called Greece’s bluff. In the battle of brinkmanship, Greece was forced to blink first.

The European economy more broadly is also doing well, with falling unemployment, modest economic growth and “above-average sentiment in the June quarter continuing the recent trend of improved conditions in the euro area as a whole”.

In fact, to the extent trouble in Greece has helped weaken the Euro, it has indirectly helped the Euro zone (Germany in particular) by improving its export competitiveness against the United States. The Board noted European “exports had made a significant contribution to the pick-up in growth in the region”.

As for China, the intense focus on its share market slump seems to have obscured some better signs from the economy. As the Board noted, “the Chinese property market had improved somewhat; residential property prices overall had risen for the first time in a year and floor space sold had increased in the past few months”. The easing in credit conditions and increased infrastructure programs were expected to support economy growth further.

To my mind, this affirms the fact that the Chinese economy is not about to fall in a hole anytime soon – irrespective of what happens in its casino-like share market.  What’s more, the recent slump back down in iron more prices seem to more reflect the lift in shipments from Australia and Brazil – with Australian supply, in particular, being disrupted by poor weather conditions earlier this year.

The US economy, meanwhile, continues to grow well with unemployment falling. Now that the latest Greek tragedy is seemingly behind us, there seems little to prevent the US Federal Reserve from beginning to raise interest rates from September. In turn, this should hopefully push the $A down even further. Indeed, despite its recent drop to US75c, the RBA Board still felt that “further depreciation seemed both likely and necessary”.

As for the Australian economy, the Board noted that a slowdown in net immigration levels seems to at least partly explain the recent downward pressure on the unemployment rate despite continue below-trend economic growth. Of course, that’s not necessarily great news for corporate profits, as it suggest our underlying growth potential is getting weaker, not stronger.

Curiously, New Zealand is now dealing with the reverse problem as stronger population growth – due in part to fewer Kiwis leaving for Australia and more Aussies heading across the ditch – is putting upward pressure on unemployment and downward pressure on wages.

That said, with dairy prices falling, darker clouds are now hanging over the NZ economy – suggesting the net flows of would-be workers could again turn around and re-apply upward pressure on Australian unemployment instead.

The other tentative good news in the statement is the fact that business confidence has picked up, as has profits in the non-mining sectors at least. What’s more, household perceptions of their own finances were holding at “above average” levels – thanks to low interest rates and firm property prices. In short, both Australian business and consumer were developing further balance sheet capacity to boost spending further should they so wish.

The question remains, however, whether either is likely to use this capacity, or continues to cautiously sit by the sidelines.

Published: Wednesday, July 22, 2015

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