THE BIG PICTURE: Why the RBA is pleased with itself

The Reserve Bank Governor isn’t one to gloat. But you can certainly sense from the latest interest rate decision that Glenn Stevens is pretty pleased with the state of the economy. Of course, it is not just the Governor that can take credit for our laudable circumstances, it is the Reserve Bank Board more generally, as well his executive officers.

Certainly there is a nice balance to the economy at present. Consumers are reluctant to spend but investment in the resources sector is picking up. The job market is strong, but future employment growth is expected to slow and skill shortages are confined to the resources sector. The floods have caused production losses but rebuilding will provide a mild boost to the economy.

And then there is inflation – which the RBA continues to describe as ‘moderate’ – with strong competition in some markets, lower wages and a high exchange rate all combining to push underlying inflation to the lower half of the target band.

Of course, no one said setting monetary policy was easy. Consider the challenges that the economy has faced over the past few years. There was the global financial crisis, a situation that prompted the Reserve Bank to do a ‘U-turn’ on monetary policy and also prompted the Government to insulate the economy by boosting spending. And you know what? It worked. Of course, there was also the small matter that the economy was very strong just before the GFC struck. And we can also thank the impeccable timing of the Chinese industrialisation.

With the GFC out of the way, the Reserve Bank wasted no time in lifting interest rates back to ‘normal’ levels. Again, that was not without its risks. If it hiked rates too quick, the economy would risk losing momentum at a crucial juncture. And if it hiked rates too slowly there was the risk that all cylinders would be firing at the same time, leading to higher inflation.

There is plenty of debate about whether the last rate hike was a step too far, but the Reserve Bank Board can breathe easy for now. The upturn in the Asian economy, and thus demand for Australian raw materials, have served to offset weakness in consumer spending and residential and commercial construction.

The new age of consumer conservatism has been another challenge for the Reserve Bank Governor, together with the renewed uplift in the terms of trade (ratio of export prices to import prices) and, more recently the floods and Cyclone Yasi.

Now the $64 million dollar question is how long the Reserve Bank will stay on the interest rate sidelines. A rate hike in April can be ruled out, with attention turning to May. But if underlying inflation in the March quarter is still restrained by competition and the exchange rate, then rates are set to stay on hold until perhaps August.

The week ahead

Last week the ‘autumn avalanche’ hit, with investors inundated by a plethora of economic data releases. The dust is starting to clear, but there is still a healthy offering of statistics on the radar screen over the coming week.

The week kicks off with the Performance of Construction index to be issued on Monday together with the latest figures on tourist arrivals, departures and migrant flows. The construction industry is doing it tough at present but conditions in the tourism sector are more mixed, despite the lofty Aussie dollar.

On Tuesday the NAB business survey is released. It’s fair to say that business conditions are challenging at present with conservative consumers, floods, cyclones, rising raw material prices and a firm currency all providing headaches in one shape or form. Businesses will certainly feel more chipper when consumers become more confident.

And that provides the appropriate lead in to the consumer sentiment figures to be released on Wednesday. In February, the confidence index lifted modestly. But when you smooth out all the bumps, the trend index hit the lowest levels in 20 months. It is hard to see how sentiment could have changed markedly over the past month.

Also for release on Wednesday is the January housing finance data. Home prices have flattened over the past few months and this has served to bring more buyers out of the cupboards – even with the double-whammy rate hike in November. Lending probably rose by 1.0% in January after lifting by just over 2% in December.

On Thursday, the latest data on inflation and unemployment expectations will be issued alongside the monthly job data. The job market remains tight, due in large part to Government restrictions on migrant numbers. Employers have no alternative but to take on marginal workers and train them up given that they can’t obtain the appropriate skilled staff from abroad. We tip a 20,000 increase in jobs with unemployment around 4.9/5%.

Turning our attention overseas, there are only slim pickings on the US economic calendar over the coming week. On Monday consumer credit figures are released with weekly department store sales on Tuesday and wholesale sales and inventories on Wednesday. On Thursday international trade, weekly jobless claims and monthly Federal Budget figures are released with retail sales and consumer sentiment data on Friday.

Economists tip a slight widening in the trade deficit, from US$40.58 billion to US$41.5 billion. And retail sales are expected to have risen by 0.4% in February with a similar 0.4% rise if autos are excluded. US retail sales are surprisingly stronger than the situation in Australia. And if employment rises as expected, sales will get a further kick along.

Also of note, all of the top-shelf Chinese economic data releases will be issued on Friday including retail sales, production, investment, and the all-important inflation figures.

Sharemarket

The earnings season is over for another six months, and by and large the results were encouraging. In aggregate, the ASX 200 companies that reported their half-yearly results had earnings up 25% on a year ago with cash on hand up almost 24%. And when you add in the companies reporting full-year earnings, cash on hand at the 152 companies stood at $102.5 billion, up 25% on a year earlier. In short, Aussie companies have cut debt and lifted cash levels to ensure that they are well prepared to meet the difficulties ahead – and there are a few. The Aussie dollar is still high, making life difficult for exporters, import-competing businesses, global companies and retailers. Then there are the vagaries of the weather, providing further challenges. Consumers still won’t spend. And raw material prices are at lofty levels and continue to rise.

Overall company profits are still outpacing share prices. The gap should close by share prices lifting to meet the higher earnings, but of course the difficulty is working on when, and how quickly, this will occur. CommSec believes that a combination of solid earnings and a lower Aussie dollar will serve to drive the sharemarket higher in the second half of 2011. We are sticking to our view that the All Ordinaries/ASX 200 will be near 5,400 points by end year.

Happy Anniversary! On March 6, 2009 the All Ordinaries fell to lows of 3111.7 with the ASX 200 at 3145.5. But it was at that point that the new bull market began, with investors concluding that stocks had fallen too far in response to the global financial crisis. In the period since, the All Ords have rebounded by just over 57% with the ASX 200 up almost 53%. Investors that have held the faith have been rewarded.

Interest rates, currencies & commodities

Our currency strategists are sticking with their long-held forecasts – and with good reason, because they remain on the money. The Aussie dollar had been expected to be around US102 cents at the end of March, and that still appears a reasonable bet. The US economic expansion was expected to broaden, raising the prospect of higher US interest rates, and lifting the greenback – especially over the second half of the year. That view also looks reasonable given recent data. The CBA strategists are tipping the Aussie dollar to ease to around US99 cents in June, US94 cents by September and US92 cents by the end of the year.

Craig James is chief economist at CommSec.