RBA watching, waiting and anticipating a stronger year ahead.


    As widely anticipated, the RBA left the cash rate unchanged this week, judging that although the bushfires and coronavirus will weigh on growth in the short term, the impact will only be temporary and not enough to derail its forecast for the economy to return to (better than) potential growth this year. In a speech on Wednesday, Governor Lowe provided some additional detail on the central bank’s cautiously optimistic forecasts for the next two years. The government has announced travel restrictions on visitors from China, which will take a toll on the international tourism and education sectors. House prices continued to rise and building approvals to recover. Retail sales in December showed some adverse consequences from the bushfires. And Australia recorded a $67.6 billion trade surplus in 2019.

    Note that the RBA will release the February Statement on Monetary Policy on Friday. Alas, this is too late for the deadline for this week’s note. We’ll look at the details next time, but Governor Lowe’s speech did set out some of the RBA’s thinking in advance (see below).

    Finally, you can find a copy of the AICD’s pre-budget submission here, which draws heavily on the findings of our September 2019 survey of director sentiment.

    What I’ve been following in Australia . . .

    What happened:

    The RBA left the cash rate unchanged at 0.75 per cent at its 4 February meeting. The accompanying statement made the familiar point that we should continue to expect a prolonged period of low rates:

    ‘With interest rates having already been reduced to a very low level and recognising the long and variable lags in the transmission of monetary policy, the Board decided to hold the cash rate steady at this meeting. Due to both global and domestic factors, it is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target.’

    And the statement went to note that the central bank ‘remains prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.’

    AUS: RBA cash rate and easing cycles 2

    Why it matters:

    As noted in the previous Weekly, market pricing last week put the probability of a rate cut on 4 February at less than 13 per cent. And in a recent poll of 25 economists ahead of the RBA Board meeting, 22 had predicted that the central bank would stay on hold. All of which meant that the decision to leave rates unchanged on Tuesday was widely expected, following as it did better than anticipated outcomes for inflation, unemployment and retail sales in the weeks leading up to the meeting. Likewise, the RBA’s comments about low rates for a long time and a readiness to cut if required both struck a familiar note.

    That said, markets had also been curious to see what the RBA would make of the economic consequences of both the summer bushfires and the coronavirus. The implication of Tuesday’s policy statement was - not much. It noted that the coronavirus was ‘another source of uncertainty’ which was ‘having a significant effect on the Chinese economy at present’ but went on to say that it was ‘too early to determine how long-lasting the impact will be.’

    Importantly, at this stage the RBA thinks that neither the virus nor the bushfires will have a large enough impact to derail its - quite optimistic - forecasts for growth this year:

    ‘The central scenario is for the Australian economy to grow by around 2¾ per cent this year and 3 per cent next year, which would be a step up from the growth rates over the past two years. In the short term, the bushfires and the coronavirus outbreak will temporarily weigh on domestic growth.’

    There were more details on the bank’s thinking in Governor Lowe’s speech on the day following the meeting (see next story).

    What happened:

    RBA Governor Philip Lowe gave a speech to the National Press Club on the year ahead, setting out the bank’s central scenario for the global and Australian economies over the next couple of years.

    Broadly in line with the IMF forecasts discussed last week, the RBA thinks that the outlook for the global economy is ‘reasonable’ with growth set to be ‘a little stronger than it was in 2019,’ as progress on trade and Brexit issues should help deliver a turnaround in global trade and manufacturing activity, aided by easier global monetary policy.

    At home, the RBA’s central forecast for the Australian economy is for 2.75 per cent growth this year and three per cent growth next year. The unemployment rate is expected to remain around its current level (5.1 per cent) for some time before gradually falling to below five per cent by late 2021. Inflation is expected to increase gradually, with underlying inflation approaching two per cent over the next couple of years.

    The forces driving this projected increase in growth are (1) the stronger global outlook; (2) a resumption in investment in the resource sector; (3) further increases in resource exports; (4) continued investment in infrastructure; (5) continued growth in other public sector spending; (6) an anticipated turn in the residential investment cycle; and (7) an anticipated recovery in household consumption.

    Why it matters:

    The governor’s speech conjured up a cautiously optimistic outlook for the Australian economy as the RBA continues to bet on its view that the economy is ‘passing through a gentle turning point for the better’.

    As noted earlier, a key question for central bank watchers this week had been, would the bushfires and the coronavirus influence this assessment? In the case of the former, Lowe said:

    ‘The economic impact of the fires in the areas affected is very large. There have been very significant disruptions to normal activity in these areas and there has been large-scale destruction of homes, farms and businesses as well as public infrastructure. In assessing the impact of this on the Australian economy as a whole [emphasis added] we have taken into account that there will be a material rebuilding effort and that government grants and insurance payments will assist many people. On this basis, our assessment is that GDP growth for 2020 as a whole will be largely unaffected. There is, however, likely to be a noticeable effect across the December quarter last year and the current quarter. . . we estimate that the effects of the bushfires will reduce GDP growth by around 0.2 percentage points across the two quarters.’

    He was more cautious about the possible impact of the coronavirus, noting:

    ‘It is too early to tell what the overall impact will be . . .Much will depend on the success of the various efforts to control the virus so we are monitoring developments closely.’

    Lowe also discussed the RBA’s monetary policy settings. Early in his speech, he dismissed the argument that the RBA’s rate cuts were behind last year’s soft consumption growth, stressing that the actual drivers were subdued wage growth, the fall in house prices and high debt levels, and noting that in his judgement ‘if the Reserve Bank had not eased monetary policy last year, this adjustment by households would have been harder, the balance sheet repair would have been more difficult, and the economy would have been weaker.’ Later, he considered the merits of further monetary stimulus, noting that the central bank had to balance the benefits of another rate cut - supporting households with their balance sheet adjustment and delivering more exchange rate adjustment - against the risks of low rates in the form of distorting economic decisions and encouraging excessive borrowing in the context of another house price upswing. This week’s monetary policy decision indicates that for now at least the RBA feels that the costs of a further rate cut outweigh the potential benefits.

    What would make that calculus change? Lowe suggested ‘an unemployment rate trending in the wrong direction’ and ‘no further progress being made towards the inflation target’ would be needed to boost the case for another rate cut.

    What happened:

    The government announced that as of 1 February, all travellers arriving in Australia from mainland China would be subject to enhanced border control measures. In particular, apart from some agreed exceptions (Australian citizens and permanent residents and their immediate family members, and some limited exemptions for airline and maritime crews) all other foreign nationals who were in mainland China on or after 1 February will not be allowed to enter Australia until 14 days after they have left, or transited through, mainland China. The measures are temporary and subject to review.

    Why it matters:

    The travel restrictions will have a significant impact on Australian exports of international tourism and education, although the magnitude of that effect will depend on the duration of the restrictions.

    According to Tourism Research Australia (TRA), the tourism sector accounted for $60.8 billion in 2018-19, or about 3.1 per cent of GDP (and about 3.4 per cent of growth in real GDP). Tourism exports from international visitors to Australia were $39.1 billion in the same year, or about 8.2 per cent of total export earnings, while imports were $58.3 billion, with Australia running a tourism deficit of $19.2 billion.

    Tourism consumption in 2018-19 was worth $152 billion, of which 26 per cent was accounted for by international tourism. For each dollar spent by international visitors, 25 cents were spent on accommodation and food services, 20 cents on education, 18 cents on transport, 13 cents on shopping and 13 cents on food and drink.

    TRA’s latest international visitor survey (IVS) results report that in the year to September 2019 there were 1.3 million international visitors from China (about 15 per cent of the 8.7 million total international visitors) who together generated $12.3 billion of expenditure (around 27 per cent of the $45.2 billion of total international expenditure). The IVS results show that Chinese visitors spend more money and stay more nights in Australia than the average international visitor.

    In addition, the Department of Education reports (pdf) that international education exports were worth almost $37.6 billion in 2018-19. Of that total, exports to China accounted for a little over $12 billion, or about 32 per cent.

    Note, however, that since the formal definition of ‘tourism’ is not restricted to leisure activities but also includes travel for business or other reasons, including education, there can sometimes be some double counting in estimates of education and tourism exports. It’s possible to avoid this by looking at the balance of payments estimates for exports of travel services. Here, the data show that exports of travel services were worth $62.9 billion in 2018-19. That total comprised: education-related travel services, which were $37.6 billion or about eight per cent of total exports of goods and services; exports of personal travel excluding education services which were $22.4 billion (4.8 per cent of total exports) and exports of business travel services ($2.9 billion). Exports to China accounted for $16.7 billion of total exports of travel services, or about 27 per cent. By sector, China’s share was 32 per cent of education-related exports of travel services, 19 per cent of exports of personal travel ex education services, and 12 per cent of exports of business travel.

    Exports of travel services: 2018-19

    How does that stack up relative to the size of the Australian economy? Measured as a share of 2018-19 GDP, total exports of travel services were about 3.2 per cent, while total exports of travel services to China were equivalent to about 0.9 per cent.

    A final point. It’s common to use the 2003 experience with SARS as a benchmark for the potential impact of the coronavirus. But as noted last week, although that’s a helpful starting point, it also comes with several drawbacks. One of those is that the current relationship between the Australian and Chinese economies now is very different to the relationship back in 2003, with the scale of bilateral trade ties today much larger.

    Australia: Greater export exposure to China

    What happened:

    According to CoreLogic, dwelling values rose in January across every capital city and rest-of-state region, part from regional South Australia (where values were steady over the month). Prices for the combined capitals were up 0.9 per cent over the month and 5.2 per cent over the year and are now down only 3.1 per cent from their peak. Melbourne prices are now about 1.2 per cent off their peak while for Sydney the gap is slightly larger, at around 5.4 per cent.

    AUS: CoreLogic Hedonic home value index, combined capitals

    Home values are now at record highs in Adelaide, Brisbane, Canberra and Hobart.

    Why it matters:

    We noted last week that one area where monetary policy continues to have traction is the housing market, and the latest numbers remain consistent with that view. The story in January was of a modest slowdown in the pace of increase (perhaps reflecting affordability constraints biting again in Sydney and Melbourne) but also a geographical broadening of the recovery.

    What happened:

    The ABS reported that the number of building approvals in December fell by 0.2 per cent over the month (seasonally adjusted) but were up 2.7 per cent over the year.

    AUS: Building approvals (dwellings)

    Approvals for private sector houses were down seven per cent over the year while approvals for townhouses and apartments were up more than 19 per cent in annual terms.

    Trend estimates showed increases in dwelling approvals in Victoria (up 6.1 per cent), Northern Territory (4.7 per cent), Australian Capital Territory (one per cent), and in New South Wales and South Australia (both up 0.5 per cent). There were falls in Tasmania (down two per cent), Western Australia (1.4 per cent) and Queensland (1.3 per cent).

    Why it matters:

    Although not as strong as the big bounce in approvals seen in November, December’s results are consistent with the turn in the housing market seen in the past several months and provide support for the case for an improvement in the prospects for construction investment later in the year.

    What happened:

    The ABS said that nominal retail turnover in December fell by 0.5 per cent over the month (seasonally adjusted). The pace of annual growth eased to 2.7 per cent.

    Australia: Retail trade (nominal) 3

    Turnover fell in New South Wales, Queensland, South Australia, the Northern Territory and the ACT and was largely unchanged in Victoria and Western Australia. Only Tasmania saw a monthly increase in December.

    In real terms, the volume of retail turnover rose by 0.5 per cent over the December quarter (seasonally adjusted).

    Why it matters:

    After a strong November result (nominal sales had jumped by one per cent over the month), the expectation has been for some payback in December, on the assumption that the November Black Friday sales had pulled forward some of the Christmas spend. And that’s just what appears to have happened.

    In addition, the ABS noted that there were also effects from the summer bushfires and the associated haze apparent in the NSW data, with hits to food retailing and cafes, restaurants and takeaway food services.

    The quarterly volume numbers for the final quarter of the year showed some improvement, with the 0.5 per cent print beating the 0.1 per cent fall in the September quarter and the flat outcome in the June quarter before that.

    What happened:

    Australia’s December trade balance was $5.2 billion (seasonally adjusted), as reported by the ABS. Exports of goods and services rose by one per cent over the month while imports were up two per cent.

    Australia: Trade balance 3

    Why it matters:

    Last year overall was a tough one for the Australian economy, but international trade has been one of the bright spots. ABS data show that the trade balance for 2019 overall was a surplus of $67.6 billion. That was up more than $44 billion on 2018’s result, reflecting a 12 per cent jump in the value of exports relative to two per cent growth for imports.

    What happened:

    Data from the Department of Finance show the 2019-20 underlying cash balance running at a deficit of $15.2 billion in the year to December. That’s more than a billion dollars larger than the 2019-20 MYEFO projection for an underlying cash balance in deficit to the tune of around $14 billion for the same period.

    Australia: Federal government, underlying cash balance

    Total government receipts were $309 million lower than the MYEFO profile while total payments were $701 million higher.

    Why it matters:

    The Department of Finance cautions that ‘monthly results are generally volatile due to timing differences between revenue and receipts, and expenses and payments. Care needs to be taken when comparing monthly or cumulative data across years and to full-year estimates, as revenue and receipts and expenses and payments vary from month to month.’ Which means it’s important to be careful not to read too much into the monthly budget results.

    Still, the combined stories of the government targeting the first budget surplus since before the global financial crisis, the continuing debate as to whether fiscal policy should be deployed to support monetary policy, and the likely budgetary impact of both the bushfires and the fallout from the coronavirus mean that analysts will be keeping a close eye on the fiscal accounts this year. And while there’s still some way to go, and the usual pattern is for a strengthening in the fiscal position during the second half of the financial year, the impact of both the fires and the coronavirus will be to squeeze government receipts and boost spending, putting that targeted budget surplus under pressure.

    What I’ve been reading

    The RBA has released its latest chart pack.

    This piece in Nature highlights the rapidly closing gap in R&D funding between the United States and China, while preliminary data for 2019 suggest that China may already have surpassed US R&D spending.

    Stephen King on how robots and technology might change globalisation from being a force for the international dispersion of economic activity to a force for agglomeration.

    A series of interesting dialogues here. For example: Frey and Hanson on when and if the (economic) robopocalypse will arrive; Smith and Delong discuss neoliberalism; and McCloskey and Appelbaum debate markets and the state.

    Anne Case and Angus Deaton set out the problems with the Gini coefficient as a measure of inequality, mainly by focussing on what it misses about the inequality story.

    Drawing on work looking at the relationship between light intensity and estimates of ‘true’ GDP, Barbera and Hu reckon that China’s actual debt burden (roughly 300 per cent of GDP on official data as of end 2017) is actually much higher (around 380 per cent of net domestic income at end 2017, likely touching 400 per cent now). The source of the difference? Post-2009, China made huge investments in offices, apartments and infrastructure, but the authors think that rapidly rising vacancy rates mean that this investment delivered a declining rate of economic value. Or, in other words, ‘buildings kept going up in increasing numbers, but fewer and fewer lights went on.’

    Paul Schmelzing has published a new Bank of England working paper looking at eight centuries of global real interest rates. A key finding is that, since some major monetary upheavals in the late middle ages, his sample of advanced economies has seen an annual trend decline in real rates of between 0.6bp and 1.6bp, and that there has been a gradual increase in real negative-yielding rates. Schmelzing argues that seen in this (very) long-term context, current low sovereign bond yields are converging back to their historical trend, and that real rates could even become permanently negative: ‘the long-term historical data suggests that, whatever the ultimate driver, or combination of drivers, the forces responsible have been indifferent to monetary or political regimes; they have kept exercising their pull on interest rate levels irrespective of the existence of central banks, (de jure) usury laws, or permanently higher public expenditures. They persisted in what amounted to early modern patrician plutocracies, as well as in modern democratic environments, in periods of low-level feudal Condottieri battles, and in those of professional, mechanized mass warfare’. Quartz has a short summary of his paper here.

    The January 2020 edition of the Journal of Democracy is free for download. There are some interesting contributions from Fukuyama, Mounk and Diamond, with a focus on the factors behind the so-called Democratic Recession, which has seen some measures of international democracy in retreat since 2006.

    The McKinsey Global Institute (MGI) has released a new report on climate risk and response. The report projects that the level of physical climate risk will increase by 2030 and increase further by 2050, with consequent increases in socioeconomic impact (including shifts in liveability and workability, disruption to food production, damage to and destruction of physical assets, disruption of infrastructure services, and destruction of natural capital) of between roughly two and 20 times by 2050 versus current levels. It also argues that both companies and communities are likely to need to significantly increase both the pace and scale of adaptation.

    Brynjolfsson and Collis discuss some of the problems involved in measuring the digital economy (because GDP is based on what people pay for goods and services, if something has a zero price, it therefore has a zero weight in GDP; as a result, the formally measured contribution of the information economy as a share of GDP has barely changed for four decades) and propose a solution that involves asking people how much they benefit from services such as Facebook or Good Maps (by asking e.g. how much an individual would need to be paid to give up say Facebook for a month). Their findings suggest that there’s been a substantial increase in consumer welfare that has been missed by traditional metrics such as GDP or productivity. However, they point out that this alone is not enough to explain the ‘missing productivity’ puzzle in contemporary economies, since past inventions including radio, television and antibiotics were subject to similar measurement problems.

    This WEF report looks at the jobs of tomorrow. It argues that demand for ‘human’ and ‘digital’ factor will drive growth in the professions of the future, with roles reflecting both the adoption of new technologies (for example, green economy jobs, jobs in the data and AI economy, new roles in cloud computing) and those based on the continued importance of human interaction (for example, jobs in the care economy, and roles in marketing, sales and content production).

    Tyler Cowen speculates that the Coronavirus could boost the re-election chances of President Trump.

    Related, the Coronavirus as the world’s largest work-from-home experiment.

    Finally, Martin Wolf is sceptical about the realism of the UK’s apparent approach to trade negotiations with the EU.

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