THE BIG PICTURE: Why the RBA doesn’t need to move on rates

With the first Reserve Bank Board meeting for 2011 scheduled for Tuesday, it’s opportune to do a stock take of our current economic fortunes.

First there is inflation. The December quarter figures confirm that inflationary pressures are well contained with prices up just 0.4%. In fact, the number of goods that are lower in price than a year ago is the highest for at least 20 years and probably the highest on record. And underlying inflation is at decade lows. Sure, the floods will lift food prices, but at the same time, retailers are engaged in massive discounting, keeping inflation in check.

Second, there are the gauges of activity across the economy. The Performance of Services index has been below a reading of 50 for the past 10 months – indicating that the sector is going backwards. The equivalent indexes for manufacturing and construction are showing similar trends – that is, the sectors are contracting.

Then there is the housing sector. New building approvals fell 4.2% in November, the seventh decline in eight months. Over this time period building approvals have fallen by 23% so it is clear that home building has started 2011 in poor shape.

And retailers also aren’t cheering at present. Retail spending rose 0.3% in November after a 0.8% slide in October. Annual growth of retail spending is close to the lowest levels seen in the past five years while chain store sales are growing at the slowest pace in 16 years. Retailers are actively discounting because consumers won’t spend and the news doesn’t look like getting better any time soon.

Then there is the job market. Up until recently, the job market had been the stand-out with employment rising strongly since June. But in December employment rose by just 2,300 positions while the Advantage job ad index fell by 2.3% in the month – the biggest fall since July 2009.

And then there are the floods, disrupting coal production and general business activity. Certainly the repair and refurbishment activity will lift economic growth in the future. But that is still down the track.

Overall it is clear that the economy has lost momentum, perhaps even contracting slightly in the December quarter. And at the same time, inflation is under control. So the Reserve Bank can sit tight on interest rates – there is no need to be lifting or cutting rates at present. We still believe that the economy will get over this flat patch, especially with our resources in big demand by Asian economies. But rates are going nowhere for now.

The week ahead

With schools returning after the long summer break, no doubt more investors will be back at their posts. And there will be a barrage of Australian and US economic data to welcome people back in the coming week.

In Australia, private sector credit or lending figures are released on Monday together with the RP Data-Rismark home price index. Credit probably rose modestly in December, up 0.2%, while another soft result on home prices is expected after the November rate hike.

On Tuesday the Reserve Bank Board meets while the Performance of Manufacturing index and the Bureau of Statistics house price series are released. The Reserve Bank won’t be touching rates, but investors will closely dissect the accompanying statement to gauge any subtle shifts in emphasis.

On Wednesday the Bureau of Statistics will release price data on a raft of food items. The Bureau plans to cease production of this series – a huge disappointment as this is the only publication that details the actual prices of items regularly purchased by Aussie consumers.

On Thursday, building approvals, international trade and the Performance of Services index will be released. We expect that building approvals improved modestly in December, lifting by 2%. And a trade surplus of $1.8 billion is tipped for the month.

And on Friday the Reserve Bank releases the Statement of Monetary Policy which should include estimates of the impact of the floods on the broader economy.

In the US, the week kicks off with data on personal income and spending on Monday. Economists expect firm readings with income up 0.4% and spending up 0.5%. Purchasing manager surveys for New York and Chicago are also released.

On Tuesday the ISM manufacturing gauge is released together with construction spending and car sales figures. Any reading for the ISM gauge above 50 means manufacturing is expanding and the current result stands at 57.0.

On Wednesday the Challenger job layoff series and ADP employment survey are released – two useful readings on the state of the job market. The ADP survey reported that 297,000 jobs were created in December, but that strength wasn’t picked up in the official non-farm payrolls report.

On Thursday, the ISM services index is released together with factory orders, productivity and the weekly jobless claims data (new claims for unemployment insurance).

And on Friday, the January non-farm payroll report is released – the official gauge on job market conditions in the US. While unemployment fell in the latest month, the concern was that this reflected people giving up the search for jobs, not more people finding work.

Sharemarket

The quarterly US profit-reporting or earnings season continues in the coming week, although the majority of bellwether companies have already issued earnings. Among companies reporting on Monday are Exxon Mobil and Anadarko Petroleum. On Tuesday earnings are expected from Lexmark and BP. Profit results on Wednesday include those from AOL, Time Warner, YUM! Brands and News Corp. On Thursday Kellogg, Mastercard and Merck release earnings. And on Friday Fortune Brands will be among a small group of companies to report their results.

So far in the US earnings season, around three-quarters of S&P 500 companies have beaten market expectations with their results – consistent with profit-reporting seasons over the past year or so.

Also in the coming week the Australian earnings season will have its customary slow start with a number of small and mid-sized companies to release half-yearly profit results.

Interest rates, currencies & commodities

In 2010 the Australian dollar was the second strongest currency in the globe, lifting by 12% against the greenback. So how is it faring in 2011? The first month of the year is almost over and the Aussie dollar is actually in the cellar, rather than on the top shelf. Of 120 currencies monitored, the Aussie dollar has eased by 2% against the US dollar, giving it a ranking of 113. Interestingly other high performers from last year are also under-performing with the Japanese yen, South African rand, Thai baht and Mongolian tugrik all lower against the greenback since the start of the year.

Financial markets continue to believe there is more chance of a rate cut in the next three months, than a rate hike. The one-month overnight indexed swap rate stands at 4.72% with the three-month rate at just under 4.75%.

For most of the period from the mid 1980s to 2002, freight costs went sideways. In fact, the Baltic Dry index broadly held between 1,000-1,500 points. Then came the ascent of China and the index soared to almost 11,800. More ships were needed, and more ships were supplied. The end result? Freight costs have slumped with the Baltic Dry index now at a 2-year low of 1,234. This is good news, especially with steel production at record highs.

Craig James is chief economist at CommSec.