THE BIG PICTURE: The RBA’s message to businesses

The release of the Reserve Bank Board minutes and no less than three official speeches in recent weeks has ensured that the policymakers have been able to flesh out their thoughts on the economy. And if there was one standout thematic it would be that central bank seems content with current state of the economy and is focused on the challenges ahead.

Certainly there is a degree of balance to the economy at present. Consumers are reluctant to spend but investment in the resources sector is picking up. The job market is tracking sideways, but skill shortages are confined to the resources sector. And while residential construction is weak it is being offset by a ramp up in investment plans and surge in engineering construction. In addition the sluggish retail sales activity is in contrast to the overall strength in household consumption.

In fact even from an economic sense interest rates are near long-term averages, inflation is in the middle of the target band and economic growth is near trend. In short there is no urgent need to cut rates again.

It is clear from Reserve Bank rhetoric that the focus is clearly shifting to massaging the Australian economy through future challenges – including the structural adjustment in labour and capital resources from non-mining to mining sectors. In addition the focus on productivity continues to be discussed. In essence the Reserve Bank is alerting businesses to the need to be fluid, and adjust to the seismic shifts that are taking place and will define the economic landscape in years to come.

There is plenty of debate about when the next rate cut should take place. Interestingly financial markets are prices in just one rate cut in the next 12 months. And while the central bank seems more upbeat compared with a couple of months ago there are still downside risks that can materialise – particularly given that while the “worst case scenario” has been avoided in Europe further shocks are possible.

As such CommSec still expects one further rate cut to take place in May (after the release of the March quarter inflation data). Another rate cut would help to shore up domestic confidence rather than providing any significant degree of stimulus.

The week ahead

Last week we spoke about a thinning out of the economic calendar. Well the coming week calendar looks like a virtual wasteland in terms of fresh economic or financial events to provide direction for investors. Certainly that is the case in Australia, although there is still a good spattering of economic data in the US.

In Australia, the focus in the early part of the week rests with the Reserve Bank. On Tuesday a speech by Assistant Governor Guy Debelle kicks off proceedings and on Wednesday the Reserve Bank releases its bi-annual Financial Stability Review. Interestingly the speech is titled “Bank Funding”, and will provide the Reserve Bank with the opportunity to flesh out its views on the cost of borrowing for the domestic financial sector. In addition the Financial Stability Review should result in the financial sector been given a clean bill of health.

On Thursday the ABS releases March quarter data on job vacancies. Job vacancies fell by over 6% in 2011, marking the biggest fall in 9 years as the slowdown in the domestic economy took its toll on labour market. Not only have there been fewer jobs on offer but even the conversion rate to job creation has been poor. However there have been signs of a modest improvement in labour market conditions in recent months.

Closing out the week on Friday the Housing Industry Association releases data on new home sales for February, together with private sector credit figures from the ABS.

In January home sales fell by 7.3% to the lowest reading in 11-years. It is disappointing that the rate cuts late last year have yet to spur new construction. Anecdotally evidence suggests that the outlook for the housing sector has improved, but the gains have been minimal and the pickup in activity seems to be in existing housing market rather than new building.

The private sector credit data tends to be a good forward looking indicator of activity. If borrowings pick up, spending should follow suit over the next few months. It is unlikely that the latest credit figures will provide any surprises, annual credit growth is holding steady at 3.5% – effectively flat in real terms. Activity has been subdued with businesses cashed up and content to use existing cash facilities rather than take on additional debt. In addition consumers have been keeping a tight rein on spending over the past year and personal credit has also remained sluggish. In fact in annualised terms growth of personal credit is holding just shy off two year lows. Overall CommSec expects credit to rise by just 0.2% for February.

Turning our attention overseas, a solid schedule of US economic data awaits investors over the coming week. The focus in the early part of the week will be the housing sector, with pending home sales for February released on Monday and with the Cash-Schiller home price series on Tuesday. Activity in the US housing sector has shown modest improvements in recent months, but the ongoing constraint has been the access to credit for potential homebuyers. Pending home sales is expected to lift by 1% in February, while home prices are likely to have eased.

Also on Tuesday, March consumer confidence survey results for February will be provided together with the Richmond Fed Manufacturing index. Consumer confidence is tipped to have eased from 70.8 to 70.5.

On Wednesday, data on durable goods orders is released together with initial jobless claims, personal consumption figures and the third estimate for US economic growth in the December quarter. Economists expect that the final estimate of economic growth in the December quarter will be confirmed at around 3.0%.

On the agenda on Friday will be the Chicago Purchasing Managers Index and data on personal income and spending for February.

Sharemarket, interest rates, currencies & commodities

Why are oil prices so high? In large part it reflects the instability in the Middle East but also the improving economic conditions across the globe. After hitting lows around US$75 a barrel in October 2011 prices have risen by over 40% in the ensuing six months. Clearly the impact of sustained higher oil prices will have a dampening effect on activity, and as such it is in OPEC’s best interests to ensure that higher oil prices do not pose a threat to the global recovery. And while not all OPEC nations may agree on increase production targets it is encouraging that Saudi Arabia’s have said that they are prepared to meet any supply shortfalls. Saudi Arabia currently pumps around 9.9 million barrels per day but is now willing to increase production to 12.5 million barrels if needed. Only time will tell if the latest gesture is enough to reduce concerns on Middle East oil supply.

Our CBA currency strategists haven’t changed their tune. They expect that the Aussie will remain firm in the short-term, perhaps lifting as high as US108 cents by June. The key question is likely to be what the US Federal Reserve does in the second half of 2012. And the likelihood of a further round of stimulus cannot be ruled out – a result that has the potential to push the Aussie even higher. In addition on the domestic front financial markets are pricing in just one 25 basis point rate cut over the next year – effectively ensuring that the high interest rate differentials between Australia and the US will remain intact. As such the Aussie is tipped to end 2012 around US109 cents.

Craig James is chief economist at CommSec



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