Interest Rates: Today, Maybe, But May 1 Looks Better

From virtually no chance a week or so ago, the odds of a cut at today's Reserve Bank board meeting have tightened, but the May meeting remains the favourite among RBA watchers.

The case for a rate cut from today's board meeting is not as strong as one for May, but don't be surprised if one pops up at 2.30 pm today.

Nothing has changed significantly in the economy, except last week's speech and comments from federal treasurer Wayne Swan that the government will hack spending in the 2012-13 budget to get a deficit back into surplus and give the RBA room to cut once, or twice in the lead up to the budget statement on Tuesday May 8, a week after the RBA meeting.

There have been several commentaries late last week, over the weekend and yesterday that pointed out how the various factors looked at by the RBA are changing and how some of the language from Governor Glenn Stevens and other senior officials has also changed in the past month to six weeks.

Others said there would be no rate cut today and suggested that the recent improvement in global economic conditions might see the central bank keep rates steady for a while longer.

Yesterday's poor data on building approvals (remember this is a volatile series reflecting the surges and slumps in home unit and apartment approvals) for February is being used to back calls for a rate cut by some property spruikers.

And today's retail sales data for February will be available to the RBA board because it will be out at 11.30 am. Economists' forecasts are around a rise of between 0.3% and 0.5%

The ABS said yesterday that building approvals show that the number of dwellings approved fell 7.8% in February, seasonally adjusted, following a rise of 1.1% in January. Dwelling approvals fell in February in New South Wales (-41.2%) but rose in Queensland (13.0%), South Australia (10.1%), Tasmania (10.0%), Western Australia (5.7%) and Victoria (1.1%) in seasonally adjusted terms.

The ABS said that seasonally adjusted, approvals for private sector houses fell 3.4% in February with falls in South Australia (-11.9%), Western Australia (-8.4%), New South Wales (-2.1%), Queensland (-1.6%) and Victoria (-0.6%).

There was a 15.8% slide in the number of approvals for other dwellings, such as units and apartments which once again caused the big fall.

House prices showed a small rise last month.

According to the RPData Rismark monthly survey prices rose 0.2% nationally in March, following a 0.8% rise in February.

In Sydney, prices were up 0.4%, but they fell 0.2% in Melbourne for the month.

And the recent rise in Australian manufacturing activity ended in March as demand weakened.

The Australian Industry Group/PriceWaterhouseCoopers Australian Performance of Manufacturing Index (PMI) fell 1.8 index points to 49.5 in March.

That ended a four month rebound.

Last week's first Financial Stability Review has also been an important indicator as it shows the RBA is more relaxed about the prospects for the financial system now that the threat from Europe has retreated (even though Spain is emerging as a major problem).

Since the first rate cut last November, it has been clear the bank was looking at Europe, and then the local economy, before deciding to cut rates.

Since then Europe has improved, financial markets have surged (even Australia's stockmarket managed a 7% gain in the first quarter, but that underperformed the 11% gain in world markets, the 19.3% jump in Japan, 12% in the main US index, the S&P 500) and solid gains for even Greece (up 6.7% and outperforming the UK which saw a 3.7% rise).

Confidence among big investors is rising and the outlook for the Japanese and US economies is the best for three years (although the US in particular has seen similar confidence shredded in 2010 and 2011 by the events in Europe).

China's economy may be bottoming (the two surveys of manufacturing activity on Sunday cancelled each other with the official survey which looks at big companies was up sharply to a four month high) and the HSBC survey fell for the 4th month in the last five to levels indicating a solid slowdown among small firms (which it surveys).

But if China slides deeper, then the RBA will cut, but not yet.

So the domestic economy is back to the forefront of RBA thinking and the Financial Stability Review made it clear the bank is happy with the caution being shown by consumers who are deleveraging, saving more and spending less on housing in particular.

It's for that reason, that the chances of a rate cut have become possible today, but more probably on May 1.

The RBA knows people continue to spend on online purchases, overseas travel, cars and personal services, and not on electronic goods (with the exception of Apple's products which are booming and taking growth from retailers).

This spending is not going to trigger a competition for resources in the mining boom (not with the savings rate at 9.5%), but a surge in housing will, over the next 18 months.

That's where much of the inflationary fears reside (along with the passing on of carbon tax costs into the wider economy and embedding them in prices, which is starting to look a possibility).

The caution shown by consumers, the different spending, the high savings, high level of bank deposits, the injection of equity into home mortgages, instead of monetising it via home equity and margin loans to consumer or buy shares, gives the RBA room to cut once, perhaps twice in the next four or five months.

The bank won't cut rates to offset the impact of the carbon tax, which remains a big unknown and could see just one rate reduction ahead of July 1.

More and more analysts and economists reckon the economy isn't doing well ('East coast recession' is how Goldman Sachs describes it).

But rates are cut for the whole economy, not just sectors or regions, so it's hard to see how a tough time in Queensland can justify a rate cut today or next month.

The bad debts and profit downgrades from Stockland, QR National and Bank of Queensland suggest that Queensland remains a problem area because of the property slump and the big wet of 2011-12.

BHP's declaration of force majeure on its Queensland coking and thermal coal exports because of union bans and wet weather will upset the trade account if it persists for longer than a week.

The 3.6% or so fall in the value of the Aussie dollar against the greenback in March is another factor the RBA is watching.

It believes the dollar will weaken because of the falling terms of trade (down 4.7% in the December quarter and heading for another fall in the March quarter).

The dollar perked up and jumped to $US1.0450 in trading early yesterday, only to fall back under $US1.04 in later trading.

It regained the $US1.040 level in offshore trading overnight as markets generally started the new quarter on a solid note.

A fall to around parity with the greenback, or a touch lower, would help tourism and manufacturing, and boost export income by a small but handy amount in coming months.

The March 6 meeting minutes finished with these paragraphs:

"Members were also alert to the uncertainties inherent in assessing the response of the domestic economy to the disparate forces at work, including the very large rise in resources investment and the high exchange rate. To date, the unemployment rate had remained at a low level and inflation broadly consistent with the medium-term target.

"On balance, the Board considered that it was appropriate for interest rates to be around their average levels, which was judged to be the case at present. The Board would continue to monitor both how the global economy evolved and the course of domestic economic activity and prices."

"Average rates" means a neutral monetary policy stance, but not 'accommodative' (another words favoured by economists in these circumstances). It all comes down to how the bank judges the domestic economy.

Central banks have room to cut when running a neutral or restrictive monetary policy (usually where rates are well above the rate of inflation, as ours are now).

When the monetary policy stance is accommodative, rates don't fall, they end up rising because the central bank's fears about inflation get too much.

We will see, but a rate cut today wouldn't surprise, but no rate on May 1 would, especially if the inflation figures are reasonable.