Yes, the Reserve Bank reckons the outlook for the Australian economy has improved since late last year – something we have already remarked upon given the better data flow in the past two to three weeks.
The bank made clear its changed view of the economy (stronger growth, higher inflation for a while) in its first Statement of Monetary Policy for the year last Friday, thanks to the sustained rate cutting since late November 2011.
”Over the past few months, there have been further signs that very stimulatory monetary policy is working to support economic activity,” the Reserve Bank said.
”This is clearly evident in the housing market and indications are that dwelling investment will pick up in the coming quarters. There have also been some recent signs of a modest improvement in consumer spending and a recent pick-up in business sentiment.”
The 2.4% rise in the value of the Aussie dollar against the greenback (see markets story) confirms the changed outlook has changed the market’s view on interest rates – no change for quite a while.
That was something many economists and traders had trouble accepting when it first appeared in the post board meeting statement from Governor Glenn Stevens on Tuesday.
But it was repeated at the end of the overview to the Monetary policy statement on Friday morning, and further fleshed out in the rest of the commentary and analysis.
But that is not to say the economy’s overall health has improved dramatically – it hasn’t and there are still big questions over the health of the labour market, demand, inflation, weak wage growth and the value of the dollar (which is not as prominent as in November’s monetary policy statement.
The RBA lifted its GDP forecasts for 2013 by 0.25 percentage points to 2.5%, and said it saw the economy expanding by 2.25% to 3.25% in calendar 2014, up 0.25 of a percentage point from the forecast last November (which was a reduction).
The central bank said it now expected underlying inflation to rise to 3% by mid year, and to be between 2.25% to 3.25% by the end of this year. The bank said inflation will continue at this level (which is closer to the top end of the target range) through to June next year before falling back to between 2% to 3%, which is the target range. Inflation rose to 2.7% in the December quarter from 2.2%.
This small lift in forecast growth, if sustained will mean a lower budget deficit, lower debt – and helps undermine the doom and gloom stuff from Treasurer Joe Hockey in the mid year economic update last December. The economy is not as badly placed as the government attempted to portray it two months ago.
And while non-mining business investment remains a weak point, the rising level of activity in the housing sector and the impact that and improved consumer spending is having on retailing and other areas of consumption, will also help offset some of the drag from the weak labour market.
In fact that weakness in the labour market is now the biggest drag on the economy, according to the Reserve Bank.
It is something investors should heed because there are a couple of outcomes that could affect corporate profits in the next year.
There is a very real chance wage growth will slow even further, while inflation remains high, meaning real wage declines.
That has the potential to undermine consumer confidence and could impact spending in the huge service sector, where the RBA points out, many of the recent job losses have occurred (not so much in manufacturing or mining).
But it could very well see an expansion in profit margins for some sectors as wage costs decline.
"The labour market has remained weak, a result of growth in economic activity having remained below trend. There has been little employment growth over the past year, the unemployment rate has edged higher and the participation rate has declined noticeably," the RBA said.
"Much of the weakness in employment has been accounted for by business services, which in part reflects the effects of the shift from the investment to the production phase of the resources boom.
"Forward-looking indicators of labour demand, such as vacancies and job advertisements, have shown tentative signs of stabilising over recent months, but remain at low levels consistent with only slow growth of employment in the months ahead.
"Weakness in the labour market has seen growth of wages slow further. Various measures of wage growth are now around the lowest they have been over the past decade or longer.
"Wage growth is likely to remain moderate for some time given the weak labour market, with fiscal restraint also weighing on public sector wage growth.
"With growth of economic activity expected to remain below trend for a few more quarters at least, it is likely that employment growth will be only moderate over the coming year and the unemployment rate will continue to edge higher.
"From around early 2015, stronger economic growth should underpin an increase in labour demand, with growth in employment increasing and the unemployment rate declining gradually." the bank forecast.
The bank obviously believes that the weak growth in wages and the continuing sluggish nature of the labour market means that companies will not have any trouble with labour costs in the next year to 18 months.
If the value of the Aussie dollar remains around current levels, it believes companies will slowly start expanding production and building new facilities to take advantage of the lower currency and wage costs (not to mention low interest rates). But not yet.
"However, at this point, surveys of investment intentions for non-mining investment remain subdued and liaison suggests that firms want to see a substantive improvement in demand conditions before committing to hiring new workers or increasing investment significantly," the RBA said.
And here’s something that you won’t read in the rest of the media – the resource giants of Western Australia and Queensland have seen employment grow, not shrink, which many media and other reports would have you believe. The big weakness in the labour market has been in Victoria and NSW – the latter is a a bit of a surprise because early 2013 saw solid jobs growth in NSW.
"Labour market conditions have remained weak in most states. After relatively strong growth over the first half of 2013, employment has declined in New South Wales and Victoria over the past six months, while participation rates in both states have also fallen," the bank pointed out.
"Labour market conditions have also remained subdued in South Australia and Tasmania. In contrast, employment has continued to rise in Queensland and Western Australia over recent months, while the unemployment rates in these states have declined modestly," the RBA said.
And the job losses haven’t been all in manufacturing, as so many media, union and politicians would have us believe.
The RBA points out: "Over recent years there has been a pronounced increase in household services sector employment (which includes the health, education and hospitality industries), driven mainly by the health industry.
"More recently, growth in household services employment looks to have slowed. Construction employment appears to have trended a little higher over the past year or so, consistent with the pick-up in activity in the housing market.
"The increase in spare capacity in the labour market over the past year or so has been accompanied by a decline in various measures of wage growth to historically low levels.
"Reflecting elevated concerns of households over job security, relatively low inflation expectations and pressures for firms to contain labour costs, the forecast profile for wages has been revised a little lower over coming quarters," the Bank forecast.
On top of this, the central bank has expressed guarded concern about the level of spending cuts expected in the next year from all levels of government.
"The fiscal consolidation foreshadowed by state and federal governments implies the weakest period of growth in public demand for at least 50 years," the bank pointed out.
The big question is whether these negative factors overtake the positives in housing, retailing and confidence.
If they do, then it is quite likely the economy won’t accelerate modestly this year, as the bank is forecasting.
But that won’t necessarily mean a resumption of rate cuts. The RBA intends taking a long time waiting for the economy to evolve in 2014.
