Damn, looks like the RBA was setting up for a June hike:
The main economic news over the preceding month had been the release of the CPI, which increased by 1.6 per cent in the March quarter, with the year-ended rate of inflation rising to 3.3 per cent. The March quarter outcome had been boosted by large price rises for a few items. There had been a 15 per cent increase in fruit and vegetable prices, a consequence of the extreme weather conditions earlier in the year. More recent data from wholesale markets suggested that the prices of some fruit and vegetables had already fallen back, although banana prices were expected to contribute further to inflation in the June quarter. Fuel prices rose by nearly 9 per cent in the quarter, electricity prices increased by 5 per cent, and there were large seasonal increases in the prices of health and education services. Members noted that some further large increases in electricity prices were scheduled. Partially offsetting the rises in these various items, the appreciation of the exchange rate had contributed to falls in the prices of many imported retail goods. The price indices for clothing and footwear, furniture, household appliances and audio-visual equipment had all fallen over the year to the March quarter.
The underlying measures of inflation – at 0.7–0.9 per cent in the quarter – were a little higher than expected, although looking through the volatility in the quarterly numbers, the outcomes over the past six months had been in line with expectations last November. On a year-ended basis, underlying inflation had remained at 2¼ per cent, down from a peak of a little over 4½ per cent in 2008.
There had been only a limited amount of data on domestic activity released since the previous Board meeting, but this had had a slightly more positive tone than earlier in the year when natural disasters dominated the news. Business conditions, as measured by the NAB survey, recorded a significant rise in March to above-average levels, and business credit rose by 1 per cent in the month, the strongest outcome since late 2008. While there had been no new official data on retail sales since the previous meeting, the staff’s liaison suggested modest growth in volumes over the past month or so.
The unemployment rate had declined to 4.9 per cent in March, its lowest level in more than two years. Employment was estimated to have risen solidly in the month after no net growth over the previous three months. The participation rate remained close to its record high and average hours were gradually picking up. Forward-looking indicators continued to point to fairly solid labour demand in the period ahead.
Conditions in the housing market remained subdued, with prices in most cities either flat or down over the past few months. Auction clearance rates in Sydney and Melbourne had been at below-average levels in recent months. Members observed that growth in housing credit had slowed in recent months, while building approvals and home loan approvals had also softened in 2011. While this partly reflected the effect of the Queensland floods, conditions had softened in most other states as well in the wake of the increase in housing loan interest rates in November.
In the resources sector, liaison continued to point to a larger contraction in coal production in the March quarter than had earlier been expected, reflecting problems in removing water from flooded mines. As a result, there was a high likelihood that GDP had declined in the March quarter. In contrast, domestic demand was likely to have grown solidly in the quarter.
Members were briefed on the updated staff forecasts. Notwithstanding the divergences between regions, the world economy was expected to grow at a modestly above-trend pace over the next few years. Australia’s terms of trade were expected to rise by around 10 per cent over the March and June quarters, to be more than double their average level in the 1990s, before falling back a little over the forecast period as additional global supply of resources came on line.
As had been the practice over the past couple of years, the domestic forecasts were based on the assumption that the cash rate moved in line with expectations implied by market pricing. The medium-term outlook for the domestic economy remained similar to that discussed over the past year or so, although the growth forecasts had been lowered a little owing to the further appreciation of the exchange rate and its effect on trade-exposed sectors. Nonetheless, for most of the forecast period, growth was expected to be at, or above, trend, underpinned by a boom in investment and the income boost from the very high level of the terms of trade. As a result, the unemployment rate was expected to continue to decline gradually. In the short term, the quarterly profile for GDP would be significantly affected by the floods, with a significant bounce-back in coal production expected in the June and September quarters. Members also noted the prospect of significant fiscal consolidation over the next couple of years.
The moderation in inflation looked to have run its course. Given the March quarter outcome, the forecast for underlying inflation over 2011 had been lifted a little to around 3 per cent. For 2012, underlying inflation was expected to remain around that level, with the gradual pass-through of the exchange rate appreciation providing a partial offset to rising inflation pressures for non-traded items. By the end of the forecast period, underlying inflation was expected to be above 3 per cent. Headline inflation was forecast to remain above underlying inflation for the remainder of 2011, largely owing to higher fruit and vegetable prices. It was then expected to be below underlying inflation for much of 2012, as banana prices returned to more normal levels.
In terms of risks, members noted the challenges for policy-makers internationally in dealing with the pick-up in global inflationary pressures. Sovereign debt concerns, both in Europe and the United States, remained an additional risk for the global economy. Domestically, one area of uncertainty was the behaviour of the household sector and whether the recent cautiousness of households would continue. Another uncertainty concerned the tightening of the labour market and whether a pick-up in wages in the resources sector would spill over into significant pressure on wages elsewhere in the economy. Members observed that the behaviour of households and the labour market would be important determinants of the outcome for inflation over the next few years. In addition, it would be important that inflation expectations remained anchored and that economic policies were conducive to productivity growth.
… Members noted that the data becoming available for Australia were being significantly affected by earlier floods and Cyclone Yasi. The inflation rate had been boosted by a large increase in fruit and vegetable prices, and it was quite likely that GDP would be shown as having contracted in the March quarter because of the disruption to production in the mining sector. As discussed at the previous meeting, members remained of the view that it was appropriate to look through the temporary effects on inflation and growth and to set policy based on the medium-term outlook.
Recent data confirmed above-trend growth in the world economy, which was boosting commodity prices. In turn, this was supporting real incomes in Australia and leading to very high levels of investment in the resources sector. The outlook for economic activity remained largely unchanged. While there were many uncertainties about the world economic outlook, the central scenario was for a continuation of above-trend growth. Growth in Australia was expected to be relatively strong over the next few years, with the unemployment rate moving lower.
The recent CPI outcome had been higher than expected, although this followed an unusually low figure in the preceding quarter. While underlying inflation was currently in the lower half of the target band, it looked to have troughed and was expected to increase, over time, from there. The recent appreciation of the exchange rate and a continuation of the relatively high saving ratio by households would help to contain some of the inflationary pressures coming from the resources boom. Nonetheless, the staff forecast was for underlying inflation to be in the top part of the target band over the next couple of years and, based on the interest rate path implicit in recent financial market pricing, above 3 per cent towards the end of the forecast period.
Members viewed the current mildly restrictive stance of monetary policy as remaining appropriate, with recent rises in the exchange rate likely to have further tightened conditions, particularly in some sectors of the economy. Members noted that the significant divergences between different sectors of the economy presented challenges for policy-making, but that monetary policy had to be set for the needs of the overall economy. In this respect, members judged that if economic conditions continued to evolve as expected, higher interest rates were likely to be required at some point if inflation was to remain consistent with the medium-term target. Members agreed to continue to assess carefully the evolving outlook for growth and inflation at future meetings.
The RBA cleary sees the economy recovering from a post-flood funk and equally clearly still expects the consumer to launch into a spending spree at the first opportunity. Trouble is, every data release before today’s Lending Finance has has been soft and weakening. We’ve had a weakening NAB survey (with rising labour cost component), crap employment, bad housing finance, falling car sales and my own corproate indicators of lousy top line numbers at Myer and David Jones, as well as profit warnings at Farifax and today Seven, suggesting marketing budgets are being pulled as the services economy weakens.
The RBA’s strong bias to raise now looks out of step with most of the services economy. But maybe that’s just how they want it and with business lending bouncing they have a case. I still think June is off but unless the RBA changes its tune a bit, not for long. If capex and/or Labour costs come in strong before the next meeting then who knows.
