Traders still love the $A

Expectations of a further rise in interest rates are still keeping the Australian dollar high.

It was trading at 96.4 US cents early today.

The latest run on the $A was set off by the publication of the minutes of the Reserve Bank board’s last meeting on May 6.

It rests, particularly, on one sentence. “Members spent considerable time discussing the case for a further rise.”

The market was clearly surprised by that observation.

But should it have been a surprise? Not according to HBOSA economist, Alan Langford.

“…they were always going to do that at the first meeting after the publication of a shocker of a CPI late last month,” Langford says.

The Consumer Price Index then showed that Australia’s raw inflation rate had risen by 4.2 per cent over the past year. That is way above the bank’s target range of 2-3 per cent inflation, over the course of a business cycle.

So is the latest flurry baseless?

Not at all, if Langford’s analysis is correct.

“So it really is no big deal that the minutes confirmed what should never have been lost sight of anyway,” he says.

“… the cash rate may yet have to rise again, before it begins to fall.

“Because if economic growth re-accelerates after only a brief and shallow dip, inflation expectations will most likely become entrenched at an unmanageable level,” Langford says.

Oh well. The strong $A will help to curb inflation, anyway.

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Wall Street plunges as the stagflation dragon appears

Soaring oil prices depressed spirits on Wall Street overnight, sending share prices down sharply.

Oil prices hit yet another new record of $US129.60 a barrel, before easing slightly to close at $US129.

That triggered fears of higher US inflation and lower spending by American shoppers.
And the Dow Jones industrial index plunged 199.48 points, to 12,828.68.

Hints that the US Federal Reserve may not be offering any more cuts to US interest rates also added to the gloom.

The S&P 500 index fell 13.23 points to 1,413.40.

And the tech-heavy NASDAQ composite index dropped 23.83 points to 2,492.26.

No fewer than 28 of the 30 components of the Dow Jones index fell overnight, Australian time.

Even before the market opened, US traders were worried about inflation.

A report had shown that US producer prices, other than food and energy, rose by 0.4 per cent in April and 3 per cent over the year.  These rises were higher than expected and the biggest since 1991.

With US growth barely perceptible – and oil prices soaring – this raised an old spectre, that of stagflation.

And that was enough to spook the market.

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$A soars on rate hints

Australian home buyers may have been horrified by the news that the Reserve bank seriously considered yet another rate rise earlier this month, but market traders were delighted.

The Australian dollar was still trading at just a touch below US96 cents this morning, the level it reached late yesterday, shortly after the minutes of the Reserve Bank board’s meeting on May 6 were published. (see Another rate rise closer than we thought).

One paragraph, in those minutes, was taken as a sign that the Reserve Bank board, which fixes rates, is still thinking of another official rate rise.And the bank’s board does have form. It has already ordered no fewer than 12 consecutive rate rises.
The board noted that its sisters, the US Federal Reserve, the Bank of England and the Bank of Canada had all reduced their countries’ official interest rates.

It noted, too, that the global economic slowdown, which precipitated those cuts, had been felt in Australia, too.

But the board noted, also, that the prices Australia is getting for its major exports, particularly iron ore and coal, are rising sharply. And the exports, themselves, are booming, largely as a result of high demand from China.

The bank’s economists fear this could leave the country awash with money, later this year, while Australia’s inflation rate is still above 4 per cent.

The Reserve Bank tries to keep Australia’s inflation within a 2-3 per cent band, a strategy that Treasury chief, Ken Henry, defended against domestic critics yesterday.

And with oil prices settling $US129 a barrel overnight, the Reserve Bank is not likely to relax, in its fight against inflation.

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Another rate rise:closer than we thought

The widely held belief that Australia’s slowing economy would be enough to curb inflation may well have been overly optimistic.

The minutes of the Reserve Bank board’s last meeting on May 6, which were released yesterday, show a very different picture.

They revealed for the first time just how close Australians came, then, to seeing another rise in official interest rates.

If if had occurred, that would have been the 13th consecutive rise in official rates.

Consider this extract, from the conclusion of those minutes. It followed long passages, pointing out that Australia is now trapped between a slowing economy, high inflation, and rapidly rising prices for its exports. These may soon add fresh pressure to Australia’s inflation rate, which is already running at 4.2 per cent.

The extract read:-

“The question therefore remained whether the setting of monetary policy was sufficiently restrictive to secure low inflation over time.

“Members spent considerable time discussing the case for a further rise in the cash rate.

“But on balance, given the substantial tightening in financial conditions since mid 2007, and the extent of uncertainty surrounding the outlook, the Board decided that it was appropriate to allow the current setting of monetary policy more time to work.”

Nothing too definitive there. And, with the bank’s economists stressing the high degree of uncertainty, now facing the Australian economy, another interest rate rise, quite soon, certainly can’t be ruled out.

The board’s minutes are one of the best assessment of Australia’s prospects, available anywhere. So, if you have time, they are well worth reading.

They are reproduced below:-
Board members were briefed on the CPI data for the March quarter 2008. The CPI rose by 1.3 per cent in the quarter and by 4.2 per cent over the year.

The various measures of underlying inflation were similar to the CPI over the latest year. The general increase in inflationary pressure was the result of strong growth in domestic demand in the face of limited spare capacity and rapid growth in commodity prices over the past few years.

In their discussion, members noted that the increase in prices over the past year had been broadly based, with three-quarters of the items in the CPI basket, by weight, rising faster than 2.5 per cent per annum. Non-tradables prices, mainly comprising services, had picked up noticeably.

Tradables prices excluding the volatile components of food and petrol were rising at less than 1 per cent per annum, and had been held down by the effect of the higher exchange rate. International comparisons suggested that inflation in Australia, on both a headline and underlying basis, had for some time been noticeably higher and was now rising more steeply than the average of the G7 economies excluding Japan. This reflected the relatively stronger demand conditions prevailing in Australia in recent years.

Domestic Economic Conditions

Members reviewed recent data on the domestic economy, most of which indicated that the pace of activity had slowed since the start of the year.

In the case of retail sales, year-ended growth had slowed to 5 per cent in March, from about 8 per cent in December. In volume terms, retail sales fell slightly in the March quarter. Liaison with retailers conducted by the staff indicated that sales of discretionary items had recently been weak. Members also noted that consumer sentiment had fallen well below average in the past few months. Buying conditions, a sub-component of the consumer sentiment measure, had fallen particularly sharply in recent months.

Turning to the housing sector, members observed that the level of new building activity was running well below estimates of underlying demand. The early signs of a pick-up in building approvals late in 2007 had since faded.

Other indicators, such as auction clearance rates, house prices and housing finance, pointed to activity in the established housing market also softening.

The available information suggested that house prices rose only slightly in the March quarter, with weakness in prices in Sydney and Perth offset by increases in prices in Brisbane and Adelaide. Auction clearance rates in Sydney and Melbourne had fallen in recent weeks and were roughly consistent with a continuation of stable house prices.

Housing finance had softened further in the past few months. Housing loan approvals as a proportion of housing credit outstanding had fallen significantly in February and another sizeable fall was estimated to have occurred in March, according to bank lending figures. Monthly housing credit growth had slowed to around 0.8 per cent on average since mid 2007, and was likely to fall further in coming months.

In the business sector, activity had slowed. On a three-month-ended annualised basis, growth in business borrowing from intermediaries had fallen from over 25 per cent at the end of 2007 to 12 per cent in February. The fall in business credit growth had been preceded by a sharp fall in commercial loan approvals, though this was typically a very volatile series. Members commented that business credit for companies with strong balance sheets was still readily available and spreads had not widened excessively.

According to the NAB survey, confidence about the business outlook had fallen over the past year and was now well below average. However, firms’ assessment of their own business conditions, reflecting activity and sales, had declined more modestly and remained above average.

Turning to the labour market, members noted that employment growth was strong in March, with the year-ended rate of increase remaining at just below 3 per cent. Given that employment lagged developments in economic activity, members judged that it was too soon to expect to see much effect in these data of the slowing in the wider economy.
Commodity Prices and the Terms of Trade

Members were briefed on the large increases in bulk commodity contract prices that had been agreed over the past month. In US dollar terms, there were price rises of 80 per cent for iron ore, over 200 per cent for coking coal and 125 per cent for thermal coal. Other commodity prices were also high at present. The price of Tapis crude oil had risen steadily so far this year, and base metals prices were not far below the peak reached in mid 2007 after having roughly doubled over the previous three years.

The rises in bulk commodity contract prices were significantly higher than previously forecast and would lead to an estimated rise in the terms of trade of 20 per cent this year. The increase in the terms of trade was expected to boost national income by about 3-4 per cent, which would be a significant potential stimulus to spending, notwithstanding possible constraints inhibiting a further rise in business and public-sector investment spending. Members were informed that, measured by the change in the terms of trade over the past five years, Australia had received a larger income gain than any other comparable country, even before taking this year’s projected increase into account.

International Economic Conditions

The Board’s discussion of the world economy began with the United States, where GDP had been quite weak; there was little growth in the December and March quarters. As a consequence, employment had fallen in recent months, including a modest fall in April. Housing starts had fallen further in March and continued to exert a considerable drag on overall growth. The low level of residential building activity meant that excess stocks of unsold new houses were being worked off, but the adjustment was slow and had some way to go.

In China, economic growth had continued to be very strong, though it had moderated slightly in the early part of 2008 as exports had slowed. The Japanese economy was slowing, according to a range of indicators of business and consumer sentiment. Elsewhere in east Asia, there were few signs of slowing. Growth in industrial production and merchandise exports for the region as a whole had, if anything, strengthened further over recent months. Members discussed the fact that inflation seemed to be an increasing problem in Asia.

In the euro area, growth in industrial production and measures of consumer and business confidence had peaked in mid 2007 and since then there had been a slowing in the pace of economic activity. Growth in the United Kingdom had also moderated, according to GDP data for the March quarter, though this was relatively mild.

The Outlook

Members were informed that the staff forecast for world economic growth had not changed over the past month. Growth in the GDP of Australia’s trading partners was expected to be a little below 4 per cent in both 2008 and 2009.

Following a review of the forecasts for domestic economic growth and inflation after the release of the CPI for the March quarter, the staff now expected non-farm GDP growth to slow to 13/4 per cent over the course of 2008. Subsequently, non-farm GDP growth was expected to increase over the rest of the forecast period, but remain below trend. This slowing in GDP reflected much weaker growth in domestic demand. This, in turn, was the net outcome of significant opposing forces: weaker world growth and tighter domestic financial conditions (some of which were due to difficulties in financial markets) were likely to moderate growth, while the strong rise in incomes resulting from the terms of trade would boost demand.

The forecast for inflation was for both the headline and underlying measures to remain above 4 per cent through to late 2008. Thereafter, inflation was expected to decline steadily to about 23/4 per cent by the end of 2010. The forecast decline in inflation was driven by the easing of capacity strains as a result of below-trend growth in non-farm GDP.

In discussing the outlook, members noted that there was considerable uncertainty in the forecasts for demand, production and inflation, given the nature and size of the opposing forces operating on the economy at present.
Financial Markets

Members examined the improvement in sentiment in financial markets that had been apparent over the past month. A summary indicator of the improvement was the narrowing of credit default swap spreads from the peaks reached at the time of the rescue of US investment bank Bear Stearns. However, spreads were still higher than in the second half of 2007.

Reporting of first-quarter earnings by a number of global banks had again been accompanied by announcements of large write-downs, but at the same time there had been substantial capital raisings. In some cases, these had been oversubscribed.

In another sign of more favourable financial market conditions over the past month, global share prices, including financial stocks, recovered from their troughs in mid March. Members noted that first-quarter US corporate earnings were not as weak as had been expected by analysts. The Australian share market also rose over the month, with a sharp rise in resources stocks.

In contrast to the general improvement in sentiment in financial markets, conditions in money markets in the major economies remained strained. Spreads in these markets had risen in April despite significant changes to operating procedures by central banks in the United States and United Kingdom, in particular. These involved dealing at longer maturities, transacting with a wider range of counterparties and accepting a broader range of collateral.

Members observed that while there had been ongoing strains in money markets in the major economies, the position in Australia was more settled, and there was a general sense that funding conditions domestically were improving. The three-month Libor to swap spread in the Australian market was now back at the low end of the international range, which had been the situation for most of the period since the onset of the financial crisis. The Bank had reduced aggregate daily exchange settlement balances to below $2 billion from the level of over $5 billion reached at the end of the March quarter. During the past month, the Bank had on occasion dealt at longer-than-usual maturities and had accepted residential mortgage-backed securities (RMBS) under repurchase agreements. This provided some support for activity in the RMBS market.

The Board’s discussion then moved to monetary policy settings around the world. It was noted that while three major central banks (the Federal Reserve, Bank of Canada and Bank of England) had reduced policy rates, central banks in many other countries were concerned about inflation. It was also noted that market expectations were that the Fed had now completed the easing process. Most other developed economy central banks had held interest rates steady. Central banks in emerging economies were generally tightening monetary policy. The People’s Bank of China, for example, had tightened monetary policy settings again and there had been increases in policy rates in India, Brazil, South Africa and some eastern European countries.

Looking at foreign exchange markets, members noted that the US dollar had recovered somewhat from the all-time low against the euro in April, but that it remained near historic lows on a trade-weighted basis.

The Australian dollar had appreciated against most currencies over the past month. The trade-weighed index had risen by 4 per cent over the month and by about 8 per cent over the past year. Members thought that the rise of the exchange rate over recent months had been less than might have been expected given the strength of commodity prices.

In reviewing developments in capital markets, members noted that bond issuance by Australian banks had returned to around average levels over March, April and early May after the very large raisings in the first two months of the year. There were tentative signs that banks’ bond spreads, while still high, might have peaked. There had been some corporate issuance in recent weeks, following very little activity in the fourth quarter of 2007. Conditions in the domestic RMBS market also seemed to be improving, following a period in February and March in which there had been a large amount of distressed selling from offshore as portfolios were liquidated. Banks had also been raising funds aggressively through deposits.

Interest rates on loans had continued to be raised across the spectrum of products. Housing loan rates had risen by 10-12 basis points in April. Since July 2007, apart from the increases attributable to the cash rate, there had been an additional 40 basis point increase on housing loans and a 55-65 basis point increase on business loans.

Members noted that there had been a large fall in margin lending in recent months, concentrated particularly in very large loans. This was an encouraging sign that the excesses of earlier years were starting to be unwound.

Current pricing in the money market indicated that no change in the cash rate was expected for the foreseeable future.

Considerations for Monetary Policy

The recommendation to the Board was to leave the cash rate unchanged at 7.25 per cent.

In considering their decision, Board members noted that there was further evidence that the growth of domestic demand had moderated significantly. Household spending had been subdued over recent months and demand for credit by both households and businesses had weakened. Nevertheless, CPI and underlying inflation had risen further and was uncomfortably high. Price rises had been widespread, in an environment of limited capacity and strong growth in demand in recent years.

Financial conditions were now tight, following the rises in the cash rate since mid 2007, the additional market-induced increases in lending rates and the tougher lending standards for some borrowers imposed by lenders in the past few months.

Looking ahead, members could see powerful opposing forces affecting the Australian economy. On the one hand, the slowdown in the developed economies, the ongoing strains in world financial markets and tight domestic financial conditions were working to slow demand and activity. Working in the other direction was the larger-than-expected stimulus to domestic incomes from the rising terms of trade that would flow from the very large recent increases in bulk commodity contract prices. Members acknowledged that the net effect of these forces on the prospects for growth and inflation was highly uncertain.

Board members noted the importance of reducing inflation if Australia was to avoid a prolonged period of economic difficulty. The staff forecast was that inflation would return to the target by the end of the forecast period in 2010, if the recent slowing in demand was sustained. This would most likely be associated with output growth falling to quite low rates in the year ahead, something that was required to ease pressure on capacity and slow the pass-through by businesses of higher input costs. Even so, members noted that the forecast path for inflation involved it remaining above 4 per cent for much of 2008. This carried the risk that expectations of high ongoing inflation could develop, which could in turn affect price- and wage-setting behaviour.
The question therefore remained whether the setting of monetary policy was sufficiently restrictive to secure low inflation over time. Members spent considerable time discussing the case for a further rise in the cash rate. But on balance, given the substantial tightening in financial conditions since mid 2007, and the extent of uncertainty surrounding the outlook, the Board decided that it was appropriate to allow the current setting of monetary policy more time to work. However, should demand not slow as expected or should expectations of high ongoing inflation begin to affect wage and price setting, the outlook, and the stance of policy, would need to be reviewed. The Board would need to evaluate prospects for economic activity and inflation in the light of incoming information.

The Decision

The Board decided to leave the cash rate unchanged at 7.25 per cen

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Oil dampens Wall Street rises

Soaring oil prices – which touched a record $US127.77 a barrel – dampened trading on Wall Street overnight, Australian time.

However, the Dow Jones industrial index, which had been trading higher earlier in the day, still managed to close 41.36 points up, at 13,028.16.

Traders had been encouraged by new data confirming that the US economy is not in recession.

This came with the publication of a Conference Board report showing leading economic indicators in the US rose – unexpectedly – by 0.1 per cent in April.

This was taken as a sign that, although weak, the US economy is not actually in recession.

Oil prices were driven higher by a combination of two factors, the continuing weakness of the $US dollar and fresh worries about supplies of oil from Saudi Arabia.

The S&P 500 index also rose – by 1.28 points – to 1,426.63.

But the tech heavy NASDAQ composite index fell 12.76 points to 2,516.09.

Worries over oil prices hit consumer related stocks and high tech shares hardest.
However oil prices did ease later in the day, to close at $US127.26 a barrel.

The utilities, energy and industrial sectors did best, in the day’s trading.

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Seize environmental opportunities: Rudd tells business

The Prime Minister Kevin Rudd is challenging Australian business people to seize the opportunities now opening up in environmental protection.

But he warned a business forum in Canberra last night that the situation is urgent.

“The age of cheap oil and gas is over,” Rudd said.

“And energy security is now recognised as a key factor in geopolitics and a major driver of long term national security strategies.”

Rudd reminded his audience, too, that there had already been food riots in many parts of the world, including Bangladesh, Haiti, Indonesia and several African nations.

And he said all of this had occurred with a recorded temperature rise of just 0.6 degrees.

Rudd said that while the government is working hard to address these challenges, business leadership is still critical to the success of its environmental policies.

“Governments must create the right frameworks and incentives,” he said.

“But business leadership is needed in adopting energy efficient measures, mobilising capital, creating new markets, developing new technologies, driving innovation, deepening our skills base and developing partnerships across the whole community,” he declared.

“Government, the business community, scientific experts and community organisations must work together, if we are to tackle the challenges of climate change and seize the long term opportunities opening up for Australia, in low carbon energy technologies and environmental services,” he said.

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Feds moving in on shonky mortgage brokers

Shonky mortgage brokers will soon face tough new Federal legislation, that is now being drawn up to protect the public.

The Superannuation and Corporate Law minister, Senator Sherry, says the predatory practices of these fringe operators will not be tolerated.
He says that most of Australia’s mortgage brokers  – and home lenders – do act in the best interests of their customers.

“But, as in any industry, there will be shonky practices,” he warned.

‘We know that some brokers and lenders at the outer fringes of the market engage in inappropriate and predatory practices that may add to, rather than reduce, financial stress,” he said.

Sherry said the government is working hard to stamp out what he called “shady practices.”

He noted that Western Australia has already introduced what he called “broker specific legislation.”

This includes a licensing regime.

But Sherry said different laws in different States would not solve the problem.

“We now have eight sets of legislation across the country,” he said.

Sherry said this had increased compliance costs and produced legislative gaps.

He said the States had agreed in principle, last March, to transfer the power to regulate this industry to the Federal government.

Sherry said he welcomed that.

“One single, simpler national regime for regulating mortgages and brokers is the only logical solution,” Sherry said.

He said, too, that much work had already been done, to prepare for this change.

“This will ensure that the regulation is effective and efficient,” he said.

“That it will protect consumers, while allowing the mortgage market, including broking, to operate with minimal compliance costs.”

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W.A.’s boom sees that State’s wage growth double Australia’s

Average weekly earnings in Western Australia leapt by 10.5 per cent in the 12 months to the end February, to hit $1,260.10 a week.

That more than doubles the comparable a rise of 4.8 per cent for Australia as a whole.  That rise, though, still took the nation’s  average earnings to $1,124 a week.

These figures will have many young Australians booking the first available flight for Perth, especially as the Reserve Bank governor, Glenn Stevens, said the high demand for WA’s resources, that is coming from China and India, is likely to be sustained.

It is that demand which has led directly to WA’s wage breakout.

But are explosive growth rates, like those now evident in WA, economically healthy?

There are good reasons to wonder about that.

Wage figures, that the Statistician released on Wednesday, had already shown that Western Australia was on the verge of a wage breakout.The Statistician reported then that the labour price index, in this resource rich State, rose 5.9 per cent, in the 12 months to the end of March.

The bureau, itself, regards this  index as its preferred measure of earnings growth.

But even on that index, wage growth in WA is Australia’s highest.

And an annual growth rate of 10.5 per cent, in average weekly earnings, is not a figure that can be ignored.

So what should we make of it?

One argument is that it’s not a worry, if it is backed by increased productivity.

And the State’s iron ore mines are, certainly,  highly productive.

If, however, this AWE growth is just an early reflection of the higher prices now set for iron ore, it might well be a good reason to worry.

The Reserve Bank has already warned that Australia’s rising terms of trade could leave the country awash with money and facing a serious new threat of inflation later this year.

Perhaps WA is just showing us how that might happen.

The growth, in Australia’s wage cost index, over the past year, was much more modest at 4.1 per cent.

On almost any measure, though, Western Australia is booming.

Replicated nationally, WA’s wage cost  and average weekly earnings growth would both give the Treasurer, Wayne Swan, major headaches.Figures, like these, point straight to higher inflation and higher interest rates.

And Sandgropers aren’t parking their big pay packets, either.

They are proudly displaying their new wealth, on the State’s roads.

Car sales, in Western Australia, are currently running 41.1 per cent above the State’s long term average.

West Australians are presently buying an average of 10,356 new vehicles a month.

They are eating well, too. West Australians boosted their food budgets by 2 per cent in March.

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