The Fed’s moves in the US will have an echo here: not so much on economic activity, but on the Reserve Bank’s approach to interest rate changes
Macquarie Bank interest rate strategist, Rory Robertson reckons the RBA is now "on-hold for foreseeable future, as tighter financial conditions bite".
Those tighter financial conditions have resulted from the credit crunch and the central bank’s 1% tightenings in seven months.
In his latest note to clients, issued ahead of the release of the March 4 Reserve Bank board meeting minutes later today, he said that global financial strains have intensified since RBA Board met earlier this month.
"The RBA at that point was worried, not that the economic fallout from events offshore and in financial markets will damage our economy, but that the damage will be too small to dampen demand, and contain elevated inflation pressures."
He says the markets will now want to see what the bank was saying in the March 4 board meeting about the problems in markets, especially its views on the future of developments in world markets and their impact here.
"In September, the RBA Board considered an "alternative scenario" involving a "protracted credit crisis around the world," Mr Robertson said.
“The RBA’s analysis suggested a 2% drop in global growth "relative to the central forecast" would see a 1.5% drop in non-farm GDP growth in Australia. "The weaker economy would result in a rise in unemployment and a fall in wage growth. …the slowing in demand and lower level of resource utilisation would see underlying inflation declining by the end of the forecast period".
"After three-straight disturbing CPI reports – with the trend CPI rising about 1% per quarter – the RBA will not be surprised if another one pushes trend inflation from 3.5% to 4%. Again, the RBA is on-hold for the foreseeable future, and a further intensification of the global credit crunch could easily see it cutting within the coming 6-12 months."
In fact the RBA Governor, Glenn Stevens all but forecast a 4% CPI for the March quarter in his speech to a Treasury seminar last week. The text of that speech was released on Friday.
Mr Robertson said that "As argued here recently, a further intensification of the global credit crunch could easily see the RBA easing within the coming 12 months
"In raising interest rates in 2008, the RBA has been responding to the "here and now" of rising inflation and unemployment dropping to record-low rates, both trends driven by the biggest sustained commodity-price and "terms of trade" booms in Australia’s history. Fair enough. But the global credit crunch could easily start reversing these trends in coming quarters, as it gnaws more deeply into the underlying strength of the domestic and global economies.
"Tighter monetary policy, and tighter credit conditions in general, clearly are biting into the Australian economy. Already we’ve seen sizeable drops in share prices, and media reports have highlighted downward pressure on commercial-property prices as a result of the growing "risk aversion" of bank lenders and investors, including the shutdown of securitisation markets. Business and consumer confidence have fallen and, increasingly, anecdotes suggest emerging softness in retail spending."
And that’s some of the reasoning used yesterday by Merrill Lynch in revealing downgrades to its forecasts for the economy for this year and next.
Merrill has join the likes of Goldman Sachs JBWere in cutting growth projections as a result of the worldwide credit crunch and the impact of the US slowdown; not to mention our own evolving slowdown caused by the interest rate rises and a loss of confidence among consumers and investors.
Merrill said: " Our 2008 GDP forecast has been cut to 2.5% (from 3.1%) while our 2009 GDP forecast is lowered to 2.9% (from 3.5%). FY09 GDP growth is now forecast to be 2.3%, down from 3.1%. The key reasons for the growth downgrades are:
"Firstly, our leading economic indicator framework, which we use to gauge the likely timing and magnitude of changes in the business cycle, has weakened significantly over the past few months. Both the magnitude and breadth of weakness has increased with only one of seven variables (the terms of trade) above its long-run median level in March.
"Secondly, financial conditions have tightened materially since late last year. This includes a rapid-fire 75bp rise in the official cash rate and additional increases in mortgage and corporate lending rates due to the turmoil and aggressive repricing in global credit markets.
"Thirdly, we expect a substantial tightening in fiscal policy in the May Federal budget. Two key macro objectives of the budget will be to reduce pressure on demand and inflation, and to lift public sector savings. Our growth forecasts are well below market consensus. We have maintained our forecast of one final interest rate hike in May. (Were’s don’t)
"The demand profile and escalating stress in credit markets are consistent with rates being at a peak. Underlying inflation pressures, however, remain intense and warrant retaining a rate hike for now.
"We are downgrading our GDP growth forecasts for both 2008 and 2009. Our 2008 GDP forecast has been cut to 2.5% (from 3.1% previously) while our 2009 GDP forecast is lowered to 2.9% (previously 3.5%). FY09 GDP growth is now forecast to be 2.3%, down from 3.1% previously.
"Our forecasts are below the market consensus – which currently sit at 3.3% for 2008 and 3.2% for 2009. Importantly, while our forecast slowdown is the most severe since 2000-01, it still represents a soft landing for the Australian economy both in terms of activity and aggregate corporate earnings growt
