Terry McCrann: Lowe to stick with Goldilocks Inflation

RESERVE Bank governor Philip Lowe will kick off his first New Year meeting in the chair by leaving the official interest rate unchanged Tuesday week, writes Terry McCrann.

RBA governor Philip Lowe will leave the official interest rate unchanged. Picture: Tony Gough

RESERVE Bank governor Philip Lowe will kick off his first New Year meeting in the chair by leaving the official interest rate unchanged Tuesday week — just as his predecessor, Glenn Stevens, did in his last New Year meeting a year ago.

But as I noted before Christmas, though, Lowe would be leaving the rate unchanged at 1.5 per cent; a year earlier Stevens was leaving it at 2 per cent. Why Stevens took it down subsequently — Lowe inherited the 1.5 per cent when he became governor in September — is the foundation for assessing what might happen to the rate through the course of 2017.

A year ago the RBA did not want to cut again; it certainly did not want to follow “everyone else” down to zero. Apart from the rather basic fact that further cuts would have done little to boost the actual economy, they would arguably have poured more fuel on the overheated — Melbourne and Sydney — property markets.

At core Stevens & Co were waiting — hopefully, even pleadingly — not for Godot but for Janet; for Fed head Janet Yellen to deliver on her “promise” to raise her rate, the US official rate, and do so four times through 2016.

Former RBA governor Glenn Stevens last year was waiting for Janet Yellen to raise her rate.

That would have boosted the US dollar and taken pressure off the Aussie; thereby delivering more assistance to the real Aussie economy than cutting already low interest rates.

As it turned out the RBA — and everybody else — had to wait all year for Janet. The first — and by definition only — US rate increase came right at the end, two weeks before Christmas.

Now, the RBA came to its February decision a year ago on the back of December quarter inflation figures very similar to the ones on Wednesday.

Back then, quarterly headline inflation came in at 0.4 per cent making 1.7 per cent in total for the full 2015 year. On Wednesday, we got 0.5 per cent for the December quarter, making 1.5 per cent for the full calendar year.

The more critical — for the RBA — quarterly underlying inflation figures printed at 0.55 per cent for the December 2015 quarter; on Wednesday’s came in at 0.45 per cent for the latest December quarter.

I would describe them as — just right — “Goldilocks numbers” that’s to say, just right in particular for the RBA. Not too low to almost force the RBA to cut against its collective will; not too high to make life “difficult”.

Last year though, it went most decidedly un-Goldilocks three months later with the shocking — certainly to the RBA — March quarter inflation figures.

They showed inflation actually going negative — that is to say, prices, on average, across the economy, actually falling — in the March quarter, dragging the full-year headline down to just 1.3 per cent. The underlying rates for the quarter were more or less zero.

Those CPI numbers were released on April 27; a week later on May 3 Stevens cut the official rate to 1.75 per cent; and he cut again three months later in August after the next inflation figures showed inflation picking up only very modestly.

So the RBA is back in an almost eerily similar situation a year later. But with some very significant and potentially even potent differences.

The Trump-Yellen ‘interplay’ is going to be ‘ground zero’ for global rates. Picture: Getty Images

Once again, but this time, Lowe is waiting for Janet. She has “promised” to hike the US rate three times through the course of 2017.

But this time we also have a President Trump and a policy program — and a resultant dramatic boost to confidence across business America and perhaps subsequently consumer America as well — that could see activity in still the world’s most important economy surprise on the upside.

That’s, activity and potentially also US inflation. So the 2017 rate risk is exactly the opposite of the 2016 experience. Last year, Janet didn’t deliver; this year she could — she could be forced into — over-delivering her hikes.

Domestically, we are unlikely to see a replay of last year’s April inflation shock.

ON the surface on Wednesday’s numbers came in a tad lower than so-called “expectations”. But a finer reading of the detail showed underlying inflation slowly picking up through 2016, or at the very least stabilising around the 0.4-0.5 per cent quarterly (and, to the RBA, acceptable) level.

That’s why I suggest the commentary reaction to Wednesday’s numbers was, to be polite, oversimplified. It fell into two camps: those that saw the numbers as ruling out any rate increase over the course of 2017; and those who saw them opening the door to a (future) cut.

Absent a replay of last year’s inflation shock, we are not going to get a rate cut — in the context of the Melb-Syd property boom and those US dynamics — unless our jobless rate spikes to at least 6 per cent.

Last year, Stevens ended up being forced to cut because inflation came in so low; the only way Lowe is going to cut, absent some dramatic negative change in the global economy or financial markets, is if unemployment does the opposite.

The real rate risk is to the upside. Although let me be very emphatic, not for many months yet: “Goldilocks” inflation numbers and steady-if-unspectacular jobless numbers will see the official rate unchanged for the foreseeable future.

So, yes, the Trump-Yellen “interplay” is going to be “ground zero” for not just US rates but indeed global rates.

But what happens in China — and how this plays into our economy through both commodity prices and the property market — is also going to be a major factor for us.

BHP Billiton’s higher volumesfeed directly into our economic growth.

BHP’S IRON AND OIL MIX

BHP Billiton’s production numbers show the ongoing positive impact of the resources boom on the broader Australian economy.

BHPB — and its peers like Rio Tinto and Fortescue — are producing and exporting a lot more
“stuff”. Those higher volumes feed directly into our economic growth.

Over 2016 those companies were also getting higher prices — spectacularly higher prices for iron ore and especially met coal; with those higher prices spread over much increased export tonnages.

Those higher value outcomes boosted our export income and slashed our current account deficit.

They will also feed into higher company tax revenues and percolate across the economy. In a general sense, all that adds up to helping rule out any further official rate cuts, absent a global meltdown.

At the corporate level, the combination of investment decisions and ruthlessly effective cost-cutting has put BHPB in a very interesting place, both in its own right and in comparison with its most direct competitor, Rio Tinto.

Both (and Fortescue) can pump out a lot, a hellavu lot, of iron ore at very low cost. When prices are high, they print money. But even when prices are — relatively — low they will still make very good profits, so there is no pressure to cut production and they won’t.

What separates BHPB is its oil and gas (and its coal — even more so, after Rio’s latest sale). Its $30 billion plunge into US shale has given it a very interesting oil and gas division, qualitatively different to the iron ore.

This is because shale is very capex demanding and has a high break-even oil price.

Yes, this hurt when oil prices plunged below $US30. The plus side is the great flexibility when oil prices surge; it can bring output back very quickly.

It’s a flexibility which all-conventional oil groups don’t have, with their mix of high upfront capex and (relatively) low running costs.

It’s a flexibility that sits well with the iron ore “steady state”.

Originally published as Terry McCrann: Lowe to stick with Goldilocks Inflation