??Friday 8 June 2012

• Convention has it that the explanation of cash rate changes the day before they apply is short – usually five of six paragraphs cutting straight to the chase. ?So the RBA does not say anything it does not want financial markets to hear and digest – the quarterly 60 odd page Statement on Monetary Policy is the tome where the RBA can delve into the occasional peripheral issue.
• So when the media release includes the line ??maintaining low inflation over the longer term will require growth in domestic costs to slow as the effects of the earlier high exchange rate wane? ? it is not just to pad out the text.
• Yes, worrying about medium-term inflation is like putting all your fire-fighting resources into putting out the grass fire around the distant hay shed while the homestead burns down, but if you are an investor in long-dated bonds, it is not a contradiction in terms to be mindful of the risk of near-term deflation if GFC2 breaks out while at the same time being concerned about upside inflation risk at some stage in the life of a 10-year bond, for instance.
• So at this stage, while the interbank cash futures market continues to price in up to 100 basis points of additional cash rate cuts by the end of this year, the RBA is likely to be much more cautious than that unless one of more of the really big risks to the global economy were to crystallise.
• And big they are for sure – but risks, rather than actual on the ground outcomes is also what they are.
• From Australia?s perspective, no risk is bigger than if China?s growth slows markedly. The RBA is indeed subtly increasing its overt concerns about the middle kingdom, but there is still a wide gulf between the RBA?s views and the bloggers listing what could go wrong in China – and if it does what it means for the rest of the world.
• Nevertheless, the risks posed if China does fall out of bed with a thud should not be ignored by any means.
• While on the subject of China, the trajectory of commodity prices is generally down, although the rate of decline is by no means in the same league as during the GFC. And the pull-back in the Australian dollar in recent weeks more than offset the decline in the multi-currency denominated measure of the RBA?s own index of commodity prices in May – which is exactly what Australia?s genuinely floating exchange rate is designed to do, and has done so many times in the nearly 30 years it has been in operation.
• So when the RBA delivered a smaller, rather than bigger cash rate cut this week, actual and implied interest rates that had dipped to mega low levels in anticipation of at least a 50 basis point cut duly tracked back up again. And then some more when the national accounts and labour force data published on the following two days were stronger rather than weaker.
• But nevertheless still evidence of a two-speed economy at work. Trend full-time employment grew at a provisional rate of 2.5 per cent in the year to may in WA and Queensland combined, but fell by 0.5 per cent in the rest of Australia. And solid growth in household consumption nationally masked strong growth in the consumption of discretionary services at the expense of traditional retailers of goods, as well as the price discounting retailers are needing to offer to keep the volume of sales turning over.
• Still, what would the ECB chief give to have Glenn Stevens? two-speed economy ?problem? as the euro debt crisis threatens to engulf Spain even though Madrid?s net debt to GDP ratio is on a par with the German one from which bond risk premia are benchmarked. But Spain?s debt burden is expected by the IMF to be 25 percentage points higher than Germany?s by 2017, while the euro area?s fourth largest economy has an inferior capacity to ride out a prolonged and/or deep recession on the continent – like the one implied by the local interbank cash futures market pricing, in fact – than is Germany?s.

See attached file: WeeklySnapshot8June2012