Today’s meeting of the Reserve Bank board has assumed greater importance because of the market instability in the wake of the shock Brexit vote in the UK and the way yields on government bonds – including those from Australia – continue to hit new all time lows.
As well, the bank will keep a wary eye on the inconclusive result so far from Saturday’s election – it won’t be saying anything about the poll, but the potential for political upheaval and budget uncertainty (on debt and the deficit and controlling spending) has risen.
Ratings groups Moody’s and Fitch made the conditional point yesterday that while Australia’s triple-A rating is not under immediate threat from the election result’s uncertain outcome, it could be if the deficit isn’t wound back.
Moody’s senior vice-president Marie Diron said in a statement yesterday the short-lived political uncertainty would have “limited” credit rating implications for Australia and its sovereign credit profile only if the outcome “changed broad policy priorities and the effectiveness of their implementation”.
“Moody’s expects fiscal consolidation to remain a key policy objective of the new government when it is formed," it said, which is putting a lot of trust on what could be an unruly Senate with people like Pauline Hanson.
And rival, Fitch Ratings warned that the close result from Saturday’s poll could see a budget outlook and set of policies “significantly different to those set out in the 2016 budget, with negotiations potentially necessary to implement key policies”.
"Fitch will assess the government’s ability to manage public finances prudently following the election result, as well as flexibility in responding to a volatile global economic environment," its Asia-Pacific sovereigns group director, Mervyn Tang, said in a statement.
“Fitch views Australia’s overall credit profile as still consistent with a AAA rating, but political gridlock that leads to a sustained widening of the deficit would put downward pressure on the rating, particularly if the economic environment deteriorates."
Standard & Poor’s issues its report on Australia on Sunday, July 24.
But in the meantime investors would do well to understand that the rebound in share prices since the Brexit vote on June 23 has had little to do with recovering confidence and more to expectations that central banks will be cutting interest rates once again in coming months. And that includes Australia’s with August now the best month for an immediate cut.
The AMP’s chief economist Dr Shane Oliver wrote at the weekend:
“Following its last meeting the RBA expressed a degree of comfort with current interest rate settings and while Brexit-related risks have added to the case for another rate cut at this stage the RBA is likely in wait and see mode.
“That said we still expect further easing this year with the August meeting providing a better opportunity to move as by then the risks flowing from Brexit with be clearer and we will have seen the June quarter inflation data,” he wrote.
While the ripples from the Brexit vote continue to batter the UK and EU, other economies were going well up to the June 23 vote
More data last week showed the eurozone and US economies were travelling very strongly in June – manufacturing had rebounded strongly from sluggish conditions earlier in the year and in the eurozone inflation returned last month and unemployment fell to a near five year low.
US manufacturing hit a 15 month high and economists expect this week’s jobs report for June to show a rebound in the number of new jobs to around 180,000 from the very low 38,000 in May.
The Japanese economy remains stuck in deflation, but unemployment is near record lows, manufacturing is sluggish, but the continuing rise in the value of the yen is putting pressure on the economy and interest rates which are now well into negative territory (like those in Germany).
And next week sees the start of the release of the monthly and quarterly economic data for China, with the inflation data out next Sunday. The two start of monthly manufacturing surveys on Friday showed continuing weakness and sluggishness at best in many areas of the sector.
Chinese second quarter growth could dip to 6.3% to 6.5% annual according to some economists.
So the RBA, like the Fed and the European Central Bank meeting on July 21, will sit and see what the extent of the impact of Brexit and the market instability on the US, EU, UK and Japanese economies.
Do not expect local factors to be at the forefront of their RBA board’s thinking tomorrow – the bank’s senior economics staff have been looking at what the continuing slide in official bond yields means – lower inflation ahead or just the results of a flight to quality by big investors who will sell their bonds when conditions (and Brexit) becomes clearer.
The RBA cut rates in May because it was concerned that low inflation would continue into 2018 and not ease next year. The events around Brexit suggest that policy stance remains current.
But with the Brexit confusion likely to dominate Britain for months, if not years, political instability to continue until the Conservative and Labour Parties sort out their leadership woes, big investors will remain invested in bonds and will play it safe.
Britain is heading for a slowdown and the Bank of England governor Mark Carney has indicated that the central bank plans more measures to offset the expected slowdown triggered by the Brexit vote.
The Bank of England meets on July 21 and economists are looking for some sign of the types of action the bank will take to emerge from that meeting, with the ECB to provide more details on its policy reaction to Brexit at its monthly meeting a week later, and perhaps something on the continuing role of UK banks and financial groups role in the EU after Brexit.
