The Reserve Bank’s economics department had a bad year in 2011, and as a result the board is now high and dry with an official cash rate that is obviously wrong. It needs to come down by 0.5%, to 3.75%, next week.
In its February 2011 Statement on Monetary Policy, the RBA had a GDP growth forecast for the year ended December 2011 of 4.25% and for June 2012 of 3.75%. CPI inflation for June 2012 was forecast at 2.75%, the same as underlying inflation.
But then in May the bank’s economists came over all bullish and upped their GDP forecast for June 2012 to 4.25%, while leaving the December forecast at 4.25%. CPI inflation for June was cut to 2.5%. In August the GDP forecast was up again to 4.5% and while the CPI forecast was left at 2.5%, the underlying inflation forecast was jacked up to 3%.
In November wobbles started to appear and the GDP forecast was cut to 4% and underlying inflation back to 2.5%. In February this year the GDP forecast for June 2012 was back to 3.5% but underlying inflation was actually raised to 2.75%.
So the RBA’s economists have made two big mistakes: they got 2011 GDP growth horribly wrong and raised their inflation forecast in February for this financial year even as GDP was falling short.
It’s hard to know what came over them on GDP in May last year, but the statement was especially bullish about commodity prices and resource and farm exports. Maybe they were influenced by Treasury, which had a GDP forecast for 2011-12 of 4% in the May budget last year, which has also turned out to be wildly wrong, leading to a bigger than expected deficit (by almost $10 billion).
But why the RBA felt the need to be more bullish about economic growth than Treasury in the middle of last year will probably have to remain a mystery, but that rush of blood to the head in May is still dogging Reserve bank governor Glenn Stevens and his board.
With GDP growth of 3.5% and underlying inflation of 2.75% in their February SMP forecasts for 2012, the board could hardly cut rates then, no matter how hard the business people on the board were arguing for it.
The minutes for the April meeting drily say: “Members noted that the national accounts for the December quarter had shown an increase in real GDP of 0.4% in the quarter and 2.3% over the year, which were both lower than expected.”
Well, yes, that’s an understatement — as recently as November the economists were forecasting 2.75% growth for 2011; just six months earlier they’d been forecasting 4.25%! That’s almost twice reality.
One can imagine a fierce debate in the April meeting between the business people and the economists, with the latter clinging to the last shreds of their dignity. In the event they persuaded the board to wait for the March quarter inflation figure before cutting rates and hanging them out to dry.
Kerplunk! March quarter CPI inflation was 1.6%, against last November’s forecast for the year to June of 3.25% (there wasn’t a forecast for the March quarter). By February that had been slashed to 1.75%, but even that now looks too high.
Next Tuesday it will be, or should be at least, a bedraggled, hangdog group of economists who shuffle into the RBA board meeting for their presentation. And many of the board members may well be checking their emails while it’s going on, having already made up their minds to cut rates by 0.5%.
Which is what they should do.
*This first appeared on Business Spectator.
If the RBA don’t follow Alan’s advice the will surley be just delayingthe second 0.25% for a month, especially as the full 0.5% won’t actually hit the borrowers back pocket.
It will be interesting to see the impact of the cut/s. I would expect that it could quite well be very significant as a lot of the gloom in the economy is based around perceptions and expectations rather than reality. That is to say after the expected cut we would have a situation where unemployment, inflation and interest rates were all at historically low levels and growth around trend. Combine this with the fact that savings rates over the past few years have increased dramatically and we have a climate in which consumer and business confidence could spike rather quickly.
Also if as expected the dooms day predictions about the carbon tax fail to materialise the second half of this year could have significant growth.
“Also if as expected the dooms day predictions about the carbon tax fail to materialise the second half of this year could have significant growth”
Come on Jimmy. All the modelling comissioned by Treasury deals with Medium to Long Term effects of the Carbon Tax (from 2020 and beyond). The modelling indicates that over this time frame there will be minimal effects.
However, the short term effects are going to be quite substantial. CPI is estimated to go up by 0.7% (treasury) to 1% (McKibbin) over 2012-2013. (based on the average CPI of 3%, that represents a sizable increase in prices). Because of this added inflation, there will be a hit to real economic growth over the next few years.
In my opinion, I think Reserve won’t cut dramatically at the next meeting. I think they might cut small (or even leave rates where they are as the majority of the recent decrease in CPI was fruit prices coming down from peaks due to Queensland floods/hurricanes) and then wait to see the impact of the carbon tax on prices when it is implemented.
Scott – What was the impact of the GST on CPI? What was the impact on growth of this CPI increase? Don’t you think the RBA will look through this CPI increase as they did with the GST?
Also you fail to take into account just how bad the predictions form News Ltd & Abbott have been – anything short of the apocalypse will be better than predicted.
On the RBA, if as you predict there will be a real hit to economic growth because of the carbon tax, and economic growth is already slowing why would they play the wait and see game for another 3 months? Especially given the big 4 have put up rates since the last official cut.
Jimmy do you operate a business or are you an employee.
Simon – I am an accountant employed in a small firm. I work everyday with small to medium sized businesses.
And you?