THE WEEK AHEAD: Is business investing again?

The International Monetary Fund (IMF) hasn’t had a great track record of late. The IMF didn’t foresee the US financial crisis. Then it became far too gloomy with its forecasts on global growth, downplaying the strength in the Asian region. And then the IMF has been slow to upgrade forecasts for the global economy. The Reserve Bank has said as much, noting in the latest Board minutes that while the IMF had upgraded its outlook, the RBA forecasts had already been “significantly higher”.

Now the IMF is offering advice to central banks on the way it conducts policy. Many central banks conduct monetary policy with some inflation goal in mind. In Australia the Reserve Bank seeks to keep inflation between 2-3% over the medium-term. That inflation goal has kept the economy in good stead over time, ensuring that Australia has stayed out of recession for over 18 years. And other central banks work with similar inflation targets.

The IMF is suggesting that inflation targets should be lifted, targeting price growth closer to 4% rather than 2%. The IMF argues that if inflation targets were higher then interest rates would also be higher and that would avoid the situation that many central banks now find themselves in with cash rates close to zero.

Of course, the reason why many countries have interest rates close to zero is that central banks left rates too low for too long – namely the US Federal Reserve – sowing the seeds for the current downturn.

The IMF is saying that it may turn out that the costs for targeting inflation at 4% aren’t greatly different than keeping inflation at 2%. Well, Reserve Bank Assistant Governor Guy Debelle was asked about the latest IMF views and he rightly said that the Reserve Bank is quite happy with its inflation target.

Because high and rising inflation can have a damaging impact on economies and wealth levels, central banks have sought to specify inflation targets at a low and sustainable level. Zero is not sustainable as an inflation target and central banks have previously considered that inflation target rates of 4% or greater were also less likely to be sustained.

For those central banks that have sought to employ inflation targets, the key objective has been to define a credible, low and stable anchor for inflationary expectations. And it does all get down to credibility. If central banks set a 2-3% inflation target, the public must have confidence that the target will be consistently met. In Australia, that target has indeed been met over time and it has been a key factor behind the country’s record-breaking economic expansion. The old adage is that if it ain’t broke, don’t fix it. And that adage rings true for the Reserve Bank.

The week ahead

The Reserve Bank has said that lack of transparency about the current economic environment was a key reason that it remained on the interest rate sidelines this month. Well, the smorgasbord of data over the coming week should provide a little more clarity about how the economy is faring.

The indicator that should get most attention is the business investment (capital expenditure) figures to be released on Thursday. But also on the radar screen is another speech from a Reserve Bank official, data on wages and estimates on construction work in the December quarter.

Overall, we expect that investment rose by 2.5% in the December quarter, partially reversing the 3.9% fall in the previous three months. The RBA would be well aware that the data is backward looking and as a result the component on future business investment plans will draw the major interest.

Over the past decade, businesses have tended to upgrade financial year investment plans by around 2% in the December quarter. So if the estimate of planned investment for 2009/10 is lifted to around $110 billion or higher, the Reserve Bank would have few qualms about hiking rates at the March Board meeting.

While the investment figures dominate the coming week’s calendar, there are a few other events to also watch. Car sales data for January is released on Monday with Reserve Bank Deputy Governor Ric Battellino delivering a speech to the Sydney Institute on Tuesday. The wage price index and construction work figures are issued on Wednesday, average weekly earnings on Thursday and private sector credit (lending) and the RP Data-Rismark house price index are both released on Friday.

The car sales figures will be affected by the ending of the Government’s tax break. CommSec estimates that sales fell by around 5.5% in seasonally adjusted terms in January. If we are right with our forecast it would seem that business or “other vehicle” sales eased by around 30% in the month following the 14% rise in December. Interestingly passenger car sales are likely to have risen by around 5% underpinned by a drop in the car tariff. It is also possible that an improvement in job security and rising car affordability are also serving to lift car purchases.

The wage prices index on Wednesday may prove something of a non-event. Wages probably rose by 0.8% over the quarter and 3.1% for the year, serving to keep inflationary pressures contained.

Private sector credit probably rose 0.2% in December (released on Friday), buoyed by higher housing and personal lending. But the house price data released the same day will be of more interest. Home prices fell by 0.3% in December – the first fall in 12 months. And if home prices eased again in January, it will make the March Reserve Bank Board meeting even more complicated.

In the US, the key event is testimony by the Federal Reserve chairman on Wednesday. Clearly most questions will relate to the speed and timing of the “exit strategy” – that is, tightening of monetary policy.

In terms of economic data, on Tuesday consumer confidence, the Case/Shiller house price series and the Richmond fed manufacturing index are released while new home sales figures are issued on Wednesday. On Thursday, data on durable goods orders and jobless claims are scheduled. The revisions to the latest economic growth (GDP) estimates are issued on Friday together with existing home sales.

The data should confirm that the US economic recovery is gaining traction. Durable goods orders and house prices are expected to strengthen, while consumer confidence should record a modest rise given the recent improvement in labour market conditions. Both the inventories (stocks) of unsold new and existing homes probably eased modestly in January, with sales posting healthy gains in the month. And on Friday data should confirm that the US economy grew by around 5.5% in annualised terms in the December quarter.

Sharemarket

The final week of the profit reporting season lies ahead. Among the companies slated to report over the week include Fairfax Media, Oil Search, GPT and Amcor (Tuesday); Asciano, Woodside Petroleum, and Suncorp (Wednesday); Toll Holdings, Lend Lease, MAP, IAG and Origin Energy (Thursday); AGL Energy, Westfield, Woolworths and Crown (Friday). ANZ will issue its quarterly update on Friday.

It is clear from the profit reporting season so far that companies are more positive about the future, but it is still largely cautious optimism. Interestingly the asset write-downs which were part of the earnings landscape during the global financial crisis – and that served to depress profits – are now nowhere to be seen. Similarly, the additional provisioning for bad debts. And the good news – especially for those in search of income rather than capital gains – is that companies are generally maintaining or increasing the dividends.

Interest rates, currencies & commodities

The Australian dollar has certainly been on a roller coaster ride over the past two weeks. After hitting lows around US86c it has once again rallied to above US90c. Despite the recent volatility, the Aussie has fared much better against the British and European currencies. The Aussie is now holding at 10 year highs against the Euro, while once again closing in on the 25 year highs reached in January against the pound. Clearly the weaker economic environment in the European Union is having a major bearing on these currencies.

Craig James is chief economist at CommSec.