THE BIG PICTURE: There is little risk with another rate cut

Now is about as good as time as any for a stocktake on the economy. And interestingly many are calling Australia the boom and gloom economy. On the one hand our economy is still growing – unlike many others, especially in Europe – and underpinned by a mining boom. In fact the mining boom could be the biggest in Australia’s history, that is, if you judge it in terms of mining investment as a share of the economy (or GDP).


But on the other hand, consumers and businesses are gloomy. So what gives? It gets down to the fact that the majority of Australians live outside the areas that are affected by the mining boom. And in those non mining areas, the news flow has been overwhelmingly negative, not positive.

Many have been focusing on the leadership shenanigans in the Labor Party, questioning the stability of the minority government. Then there is the uncertainty about new taxes – mining tax and carbon tax. Add in the other shenanigans in Europe, the fluky sharemarket, rising petrol prices and a softening economy and you can understand the downbeat sentiment.

What are the positives? Well for consumers the Aussie dollar is still high, but not everyone is buying goods on the internet or travelling abroad. And if you are a business owner in manufacturing or retail sectors, you’re probably more likely to be more ambivalent about the currency.

And then there is the recent flow of economic data. The economy grew by just 0.4% in the December quarter – hardly awe inspiring. Employment fell by over 15,000 in February and the unemployment rate rose – admittedly only from 5.1% to 5.2%. But there have also been a number of high profile companies shedding jobs. And annual employment growth is close to the slowest rate recorded in 19 years.

Then there is the weak housing market with new home sales at 11-year lows, dwelling starts slumping almost 7% in the December quarter and home loans falling in January. And then there is retail spending – up just 0.3% in January with chain store sales up only 2.0% on a year ago.

At this rate, we risk talking ourselves into a growth recession – a period of sub-trend economic growth which feels in many respects like a recession but doesn’t involve the economy actually going backwards.

So what will it take to turn it all around? Better times abroad would help, lifting our sharemarket, and causing us to re-assess our conservative attitudes. Aussies need to focus again on the opportunities, not the risks. And a rate cut from the Reserve Bank wouldn’t go astray either. Inflation is not a threat and the economy is stagnating. So there are few risks about trimming rates another quarter of a percent. And if conditions started to lift quicker than expected, a rate cut could always be reversed.

The week ahead

If it weren’t for the Reserve Bank, investors would face a fairly dull time over the next week. There are no indicators of note except imports on Wednesday but there are a number of speeches to be delivered from Reserve Bank officials. In the US, the housing market takes centre-stage.

On Monday the Reserve Bank Governor is in Hong Kong to speak to the Credit Suisse 15th Asian Investment Conference 2012 on the generic topic “Economic Conditions and Prospects”. This ensures that the Governor has a broad canvas on which to paint – that is, if there is a subject he wants to raise, this will be the forum to raise it.

On Tuesday, the Reserve Bank issues the minutes of the March 6 Board meeting, a meeting that elected to leave interest rates on hold. Certainly no economist had tipped a rate cut at that meeting, but investors will comb the minutes in an attempt to hone in on the Bank’s “hot button” issues. That may prove fruitless given that the Reserve Bank is in that “happy place” at present, but it is still a task worth exploring.

Also on Tuesday, Reserve Bank Assistant Governor (financial system), Malcolm Edey, will deliver a speech to the Cards and Payments Australasia 2012 Conference.

And on Thursday, the other Assistant Governor at the Reserve Bank (covering Financial Markets), Guy Debelle, will deliver a speech on Bank Funding to the Australian DCM Summit 2012.

In the US, there is a spattering of key economic statistics to be released with the housing market very much in the spotlight.

On Monday the National Association of Home Builders index is released alongside the Chicago MidWest regional gauge. And on Tuesday the weekly reports on chain store sales are issued alongside data on housing starts.

Housing starts broadly bottomed out a year ago and have been slowly recovering since. Economists tip a flat reading near a 700,000 annual rate.

On Wednesday the weekly mortgage market index is released together with data on existing home sales. Economists tip another modest lift in home sales of around 2%, continuing the recovery since October 2011.

On Thursday the Federal Housing Finance Agency will release its January index while weekly jobless claims and the leading index are also on the agenda. The leading index has lifted for four straight months and a 0.4% increase is tipped for February.

And on Friday the February data on new home sales for February is released. Sales are bumping along the bottom, although the annual rate is tipped to rise from 321,000 to 327,000 in February.

Also of note five Federal Reserve Governors are due to deliver speeches over the week, providing insights into central bank thinking on a range of topics. The Federal Reserve Governor delivers two of four lectures to the George Washington School of Business.

Sharemarket, interest rates, currencies and commodities

The All Ordinaries index hit cyclical lows of September 26 at 3927.6. In the five and a half months since the All Ordinaries has lifted by 11.4% and is again bumping up near the 4,400 barrier. This barrier has proven formidable since August 2011. However you get a sense that if 4,400 breaks, the next test is 4,700 and then 5,000 points.

The All Ordinaries Accumulation index has similar issues with the 33,000 mark. The key difference is that the Accumulation index has punctured 33,000 points, but not pushed decisively through the mark. Since the lows in late September last year, the Accumulation index has lifted by 13.8%.

The Accumulation index needs to rise 27% from current levels to hit the late 2007 all-time highs. Similarly the market capitalisation of the Australian sharemarket would need to rise 27% to hit the late 2007 highs.

The All Ordinaries index needs to rise by around 57% to reach the November 2007 all-time high. All those figures are in local currency terms.

But a foreign investor, pricing our market is US dollar terms, would see things far differently. Since the peak in November 2007 the Aussie dollar has lifted over 14% against the greenback. In other words, for foreign investors, valuing their Aussie sharemarket investments in US dollar terms, the All Ordinaries Accumulation index would need to rise by just 11-12% to be at record highs.

And while that target appears in reach over the next year, it still is more challenging than the task in front of the US Dow Jones index. The Dow Jones is around 1,000 points away from record highs, meaning it would just need to lift by 7.5% to be back at peak levels.

In fact, according to FactSet data, the Australian sharemarket has under-performed the US market in US dollar, total return, terms over the past one, two and four years but out-performed over the past three, five, seven, 10 and 15 years.

Given that the US sharemarket was at the epicentre of the global financial crisis, Australian investors may feel that this represents some injustice. But the high Aussie dollar has presented a barrier in front of foreign investors wishing to embrace our market. Around 45% of all Australian shares are owned by foreigners.

Craig James is chief economist CommSec.


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