Inflation, Europe and Rate Rises

Yesterdays inflation figures came out showing the RBA is unlikely to achieve their expectations of mid-range inflation. The figures pushed the upper levels of their stated band of 2%-3%. In the absence of Greece and Portugal's downgrading it would be a foregone conclusion that another rate hike was on the way.

CPI Headline 0.9% qtr 2.9% y/y
CPI Trimmed Mean 0.8% qtr 3.0% y/y
CPI Weighted Mean 0.8% qtr 3.1% y/y

Troubles in Europe have brought some uncertainty to the rate hike equation. The recovery in other parts of the world is delicate and a default by Greece, a distinct possibility, will impact Australia in some way. Our side of the world is however doing pretty well and with inflation still high, with plenty of growth potential left in the economy, the RBA will be giving a rate tightening serious consideration rather than the pause that I believe was in the back of their minds until yesterday.

Greece

The Greece issue seems to be only getting worse. Their funding costs to service the massive amount of debt they are dealing with went up overnight with S&P cutting their long-term debt rating three notches to BB+ from BBB+ with a negative outlook. They are now 'junk' status.

Inflation
Inflation numbers will be closely watched today for indications as to whether the RBA will pause or hike next month. If the figure is on the high side there will be a leaning towards a hike. Expectations are for 0.8% rise for the qtr.

RBA Speech

Governor Stevens spoke on Friday and suggested that rates are pretty close to the average of the last 10 to 12 years. They have recently started talking a lot more about 'average' rather than 'normal' as with changes in the make up of household debt levels (higher than in the past) normal is hard to define. He seemed to give a signal that a pause is fast approaching. According to the April board meeting minutes they almost paused this month so a May or June pause for some months is to be expected. The caveat here are the inflation numbers, to be released tomorrow. Expectations are for around 0.8% qtr (0.5% core) and 2.8% yr on yr (3.1% core) and the Governor indicated he thought it would be traveling within their target band.

As a consequence the yield curve has flattened slightly with the market starting to unwind some of the future rate hikes that had been priced in.

Margins

Please note that margins over wholesale rates (BBSW) have been creeping down since February. For instance margins of close to 200 over 90 day BBSW were evident from December through to Feb but are now lurking around 130 / 140 over. This means that despite two tightenings in the cash rate 90 day term deposit rates in many cases are now lower. It's quite possible that this will continue (there's still a long way to go to return to pre-GFC margins of about -10) so any opportunities to lock in good margins for longer terms, either through longer fixed term deposits or floating term deposits should be seriously considered. Added to this we believe the one year part of the curve still presents excellent value give the RBA may pause for a while at 4.50% or 4.25% cash rate.

RBA Minutes

The RBA minutes were released yesterday and there are a number of interpretations. The headline from the Herald for instance reads "RBA eyes May rate rise" as if it's a foregone conclusion. My interpretation is a little different - as usual I've pasted the concluding paragraphs below. I get the distinct impression that they thought seriously about a pause and will think about one again in May. They have continuously talked about being at the "average rate" and have said we are close to that now. That means pausing at 4.25% or after the next tightening at 4.50%. Given the strength in the terms of trade I am leaning towards the latter. All the press about future hikes also has it's own 'jawboning" effect as well and serves to do some of the RBA's work for them.

Considerations for Monetary Policy

Recent data for the world economy suggested that the recovery in the major advanced economies was still tentative, but that the expansion in most of Australia’s major trading partners in Asia was proceeding strongly. This was feeding through into significant increases in the prices of resource commodities, including increases in the contract prices for coal and iron ore, which were larger than had been expected a few months ago. While there were a number of risks to the outlook for the global economy, the most likely scenario was one where growth in global output was close to trend over the next few years.

In the view of the Board, with forecasts suggesting that growth in the domestic economy in 2010 would be around trend and that inflation would be around 2½ per cent, consistent with the medium-term target, the level of interest rates in the economy would be expected to be close to average. This remained the underlying rationale for consideration of any adjustment to the cash rate in the current period. Since lending rates were still a little below average, members expected that they would probably need to rise further in the period ahead.

On the question of timing, the fact that the prospective rise in the terms of trade was now likely to be noticeably stronger than had been expected was a factor suggesting that it might be prudent not to delay adjustment. Overall, members considered that the outlook for the economy suggested that there was a case for a further step in the process of returning interest rates to more normal levels.

The Decision

The Board decided to raise the cash rate by 0.25 percentage points to 4.25 per cent, effective 7 April.

Full Statement Click Here

Housing Finance Drop

With the ending of govt stimulus figures yesterday have shown that housing finance has dropped for the fifth straight month. There is still however good strength is house prices but this may falter soon.

Loans to first home buyers has dropped 1.8% since last month. The value has fallen from more than $17 billion a month in the middle of last month to a little over $14 billion in February.

(From SMH)
US economy 'remains in recession'

The National Bureau of Economic Research (NBER) said its business cycle-dating committee met Thursday to review the most recent data for all indicators relevant to deciding whether there was an end to the recession that began in December 2007.

"Although most indicators have turned up, the committee decided that the determination of the trough date on the basis of current data would be premature," the NBER, based in Cambridge, Massachusetts, said in a statement.

Employment

Strength in the economy has shown through in the continued transference of work from part-time to full-time as evidenced in employment figures released yesterday.

While the headline rate remained at 5.3% there was an increase in numbers employed of 19,600 with 30,100 of them in full time employment.

Monetary Policy

As you are no doubt aware the RBA lifted the cash rate by another 25 points yesterday. Their press release can be accessed here and it gives a good summary of where they see the global and domestic economy at the moment.

I always find the last two paragraphs very illuminating and have pasted them below. My take is, given they say "closer to average" that they will pause to assess the situation soon after they reach 4.50%

With the risk of serious economic contraction in Australia having passed some time ago, the Board has been lessening the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker. Lenders have generally raised rates a little more than the cash rate.

Interest rates to most borrowers nonetheless have been somewhat lower than average. The Board judges that with growth likely to be around trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today’s decision is a further step in that process.

Rate Rise

After some of the weaker than expected figures last week the odds of a rate rise have been slightly reduced. A number of economists are talking about another pause which is possible. For my mind though the RBA has made it clear that they want to get monetary policy back to a less stimulatory level. At 4.00% it is still in the 'emergency' area which we are no longer in. I think they are likely to continue moving rates towards 'neutral' but if they do pause expect a hike in May.

Domestic Economy

Some figures came out yesterday showing evidence of something that the RBA has been keeping a close eye on. The rate hike process began in the midst of a flurry of government stimulus packages. The worry was that the economy may not have the legs to continue it's path of strength once the full might of those packages was reduced. The economy has held up a little more strongly than I had expected and China is largely responsible for this. Some weakness is however begining to show.

Retail sales slid by 1.4% in February - the most in a year. Building Approvals also dropped in the month falling by 3.3% following a revised fall of 5.5% in Jan. Economists had expected a rise of 2.1%.

A slew of economists have now come out suggesting the RBA will pause. Personally I think the RBA are on a course to move the cash rate closer to normal and will continue their rate hikes in April.

International

As a reminder of how lucky we are unemployment figures for the Eurozone ticked up to double digits last month at 10% (Spain is around 19%) and inflation is up from 0.9 to 1.5% now. High unemployment and high inflation is not a good combination to have!

Also Greece had a reasonably unsuccessful bond issue and Moody's has downgraded a few of their banks.