The RBA board left the cash rate unchanged at 2.75% for a second consecutive meeting in July and although the accompanying statement finished with the customary easing bias comment, signs of economic improvement internationally and locally seem to imply little reason for the cash rate to be cut any further. Over the past week or so, there have been signs that US economic growth is gathering momentum, that China is relaxing its credit squeeze, that Europe although still weak is starting to improve and that Australia has two engines of growth powering up, housing and exports
Taking the US first, several indicators point to the economic growth gathering pace. Beyond housing activity, which has clearly been improving for some time, manufacturing activity seems to be recovering from a recent soft patch with the June manufacturing ISM lifting to 50.9 in June, back in expansion territory from 49.0 in May and factory lifting by 2.1% in May after a 1.3% increase in May. Motor vehicle sales are soaring in the US, up by 4.6% in June alone to a recovery high of 16 million units on an annualized basis. Importantly, notwithstanding the headwind from government budget cuts, households are feeling as confident about spending as at any time over the past 5 years with household wealth at a record high and employment steadily rising. The latest non-farm payrolls for June rose by a stronger-than-expected 195,000 after May was revised up to 195,000 from 175,000.
US economic expansion is looking more sustainable especially with government budget issues looking more manageable and constant reassurance from the Fed that it will only pare back its bond buying program (QE) when the economy is in good enough shape to cope.
Just as the outlook for the US has been causing less concern, China has thrown up some cause for greater concern. The main issue has been the health of Chinese banks and asset managers after credit growth ran increasingly above the pace of GDP growth fostering a boom in property prices. The Chinese authorities have opted for a relatively hard line approach to squeeze credit risking near-term economic growth for better medium-term growth prospects. In late June, the Peoples’ Bank of China pushed the overnight repurchase rate to a record high above 13%, but has since allowed the rate to fall back below 4%. To many, the policy tightening seemed heavy-handed, but practically it was probably the best approach to take the steam out of excessive credit expansion. More importantly with this “stitch in time” policy approach, China looks more likely to achieve its 7.5% average annual growth objective over the next 10 years and there is also good reason that the current policy-induced pull back in growth may be short-lived.
In Europe, recent manufacturing PMI indicators are mostly looking a touch stronger and both the European Central Bank and the Bank of England promised at their July policy meetings to leave official rates lower for longer to help sustain signs of economic improvement.
In Australia, home building approvals fell by a small amount in May (-1.1%), but giving back very little of the out-sized 9.5% gain in April. Housing activity is showing signs of strong improvement, especially in New South Wales. Meanwhile, the additional capacity provided so far by the mining investment boom is showing strongly in monthly exports, up another 3.6% in May and helping to generate a surprisingly big trade surplus of $A670 million in the month. The fall in the Australian dollar since late April (over a 10% fall on trade weighted basis) will also help to underpin export growth. Retail sales are a laggard in the improving local economic outlook, but will most likely follow the lead from improving housing before long.
The RBA says that low inflation provides the scope to lower rates further if the economy needs. At this point, the case for the economy needing further rate cut assistance is diminishing quickly. Our view is that the cash rate is now most likely on hold at 2.75% through to Q2 2014, when a mild policy tightening phase may commence.