A miner conundrum for the RBA

Interest rates are likely to remain on hold at 2.75 per cent following today’s meeting of the Reserve Bank board but there will be a heated debate about the need for a further interest rate cut in the not too distant future.

The discussion over an interest rate cut is gaining momentum to the point where I would not fall off my chair if the Reserve decided to announce a 25 basis point cut this afternoon, as a run of generally softer economic news has emerged in recent days to overwhelm what had been slightly better news a few weeks ago. 

It will be a close call.

The case against cutting interest rates at the moment is built on the positives of solid trend employment growth up to April and the fact the unemployment rate fell back to 5.5 per cent. House building approvals also lifted strongly and retail spending has only edged lower after two very strong months at the start of 2013. The fall in the Australian dollar, while not an issue that has any meaningful impact on medium term Reserve Bank deliberations (Dollar dips and rate cuts go hand in hand, May 28) could add to the case today for no change but on most measures, the currency remains overvalued.

Against this platform of reasonable news is a raft of information which is somewhat disconcerting for those who welcome GDP growth, job creation and rising living standards.

Information on the global economy has certainly been no better than was assumed a month ago, and the slide in commodity prices has gained fresh impetus in recent weeks. This is especially unwelcome, as is news of a resumption of falling house prices. 

According to RPData, house prices fell 1.2 per cent in May after falling 0.5 per cent in April and already in the first three days of June, prices are down another 0.1 per cent. Household credit growth also remains weak. The cautious consumer remains evident in these figures.

The TD-MI monthly inflation gauge rose a tepid 0.2 per cent in May for an annual rise of 2.2 per cent. Recall that about 0.7 per cent of the annual increase is due to the one-off price impact of the carbon price, which took effect on 1 July 2012. Excluding the carbon effect, annual inflation is nearer 1.5 per cent, well below the bottom of the 2 to 3 per cent target band for the Reserve. Inflation is certainly not an impediment to the bank cutting interest rates again.

In addition to the hard news on ongoing low inflation, yesterday the Fair Work Commission announced a 2.6 per cent increase in the minimum wage, a moderate result that from a macroeconomic perspective should knock on the head any lingering talk of wage induced inflation. On the contrary, the recent run of data on wages points to decelerating wage pressures which should also work, with the usual lags, to keep inflation pressures well and truly in check.

Perhaps most disconcerting is the ongoing fall in the number of job advertisements measured by ANZ. They have fallen for three straight months and are now a sizable 28 per cent below their late 2010 peak. This fall in job ads is consistent with a further increase in the unemployment rate in the months ahead. The budget forecasts for an unemployment rate of 5.75 per cent from the current 5.5 per cent unfortunately looks assured.

Amid all of this, consumer confidence has fallen back sharply in recent months and the appetite for spending on big-ticket items is low. Business sentiment from both the NAB and Dun & Bradstreet surveys point to soft activity into the middle of 2013. The business investment outlook continues to be problematic, with mining likely to be the main area of softness.

The Commonwealth budget last month also locked in further fiscal tightness. Indeed, once the state and local government sector is added to the Commonwealth budget policy, public demand is going to record close to zero growth in 2013-14 and in doing so, will not add anything to GDP. 

Clearly, all of these factors suggest there is a case for an interest rate cut today and the decision will come down to the wire. The Reserve Bank’s judgment on the mining boom and the health or otherwise of the global economy will determine whether rates are cut or not. These are the two areas the bank got badly wrong over the last two years and are a reason why it has, on balance, been tardy in cutting interest rates.

This afternoon, we should have a fair idea whether the bank has learned from these mistakes – it probably should cut interest rates again, but probably won’t.