The RBA’s December Board meeting decided to increase the cash rate target by 25 basis points to 3.10%, the eighth consecutive increase in official interest rates, taking the cash rate target to its highest level since December 2012. The 300 basis points in tightening since May is the most pronounced cash rate tightening cycle on record, exceeding the 275 basis point tightening seen between August and December 1994.
Rick Morton wrote a piece for The Saturday Paper saying ‘Philip Lowe’s future as Reserve Bank governor looks in doubt – he’s short of allies as a major review looms, just months from a decision about his reappointment.’
Steven Hamilton and Jessica Irvine had pieces in the SMH that were respectively critical and supportive of Governor Lowe, although the balance of reporting around recent monetary policy decision-making has been decidedly negative. In an ABC RN interview on 8 December, Treasurer Chalmers was asked about Governor Lowe’s future in the context of the RBA review:
To one of Hamilton’s points, I think the reason the RBA has struggled so much with communications strategy is that it didn't develop the necessary comms skills and disciplines when it previously faced so little effective scrutiny, not least from many in the media. It became conditioned to operate in environment where its pronouncements were taken as oracular, even when not economically coherent, which has left it poorly equipped now that its decisions are under intense scrutiny. It is difficult to develop a coherent communications strategy around what has often been an incoherent reaction function. One important task for the review in my view is to look at the consistency of the RBA’s pronouncements and its economic and policy narrative over time, rather than at a given point in time.
In many ways, the review of the RBA could not be more timely in ensuring that scrutiny of monetary policy decision-making in relation to the current tightening cycle translates into constructive reform proposals that avoid over-personalising issues that are really about governance, transparency and accountability. These are all responsibilities of government and if the review finds shortcomings in the current arrangements, then successive governments own those shortcomings as much as the Bank.
The RBA review has released the public submissions that it has received. 78 were published, but the submission numbering goes to 113, so we can infer at least 31% of submissions received were confidential. There is a handy search box on the review web site so you can search the content of the submissions. Nine submissions reference nominal GDP/income targeting. I am referenced in three.
Peter Tulip discusses the submissions to the review in this interview with Ross Greenwood, noting that there is very little defence of the existing institutional arrangements in the submissions. Peter questions whether these arrangements can persist in the absence of widespread support for the status quo:
The RBA has simultaneously released its 86-page response to the very comprehensive requests for information received from the review panel. The main takeaway from that release has been that the RBA did not act on the conclusions of its pre-pandemic deliberations about the potential problems with calendar-based forward guidance. Zac Gross argues that the RBA is stonewalling the review on questions around why the RBA acted contrary to its previous conclusions. No doubt the review will have something to say about the issue.
Has the current account balance normalised?
The reverse Pitchford has gone into reverse. Australia’s Q3 current account recorded a deficit of $2.3 bn or -0.4% of GDP, the first deficit following 13 consecutive quarters in surplus, the longest run of surpluses since the 1940s. This was a sizeable $17 bn turnaround on the second quarter surplus of $14.7 bn (2.4% of GDP).
The deficit was driven by both a narrowing of the trade surplus and a wider net primary income deficit. The terms of trade fell 6.6% in Q3, the largest decline since June quarter 2009. The previous quarter was a record high going back to 1870 based on the Gillitzer and Kearns (2005) reconstruction of the historical terms of trade, exceeding the Korean War high from the 1950s.
The current account deficit means that Australia was a net importer of capital over the quarter for the first time since 2019. However, we still managed to export a net $25 bn over the year-ended in September.
Net foreign direct investment was flat over the quarter, with gross inflows of $30 bn matched by gross outflows of $30 bn. Over the year, we still have $38 bn in net FDI outflows, with gross outflows a massive $172 bn and inflows of $122 bn. Net FDI flows were -8% of GDP for the year. Australian firms are doing more investment abroad than foreign firms are investing in Australia.
Portfolio investment recorded net inflows of $5.3 bn in Q3, with gross outflows of $2.7 bn offset by gross inflows of $8 bn. Over the year, there was $85 billion in net inflows, with $80.6 billion in gross outflows offset by $166 bn in gross inflows. Portfolio investors in both directions were sellers of equities and buyers of debt securities.
Overall, the resumption of net capital inflows in Q3 is a welcome sign of normalisation in Australia’s external accounts, but the small deficit on the quarter is much narrower than the historical average since 1959 of -3% of GDP.
As argued here previously, a current account deficit is to be preferred over a current account surplus given that the former represents an excess of investment demand relative to domestic saving. We should be wary of over-weighting a single quarter relative to the previous 13, but the current account is at least heading the right way. The new private business investment share of GDP remains near 30-year lows, so much of this is being driven by declining saving rather than booming investment. We should remain concerned that we are still a net exporter of direct investment capital on an annual basis. In an op-ed last year, I suggested that restoring net inflows of people and capital should be viewed as complementary elements of the post-pandemic recovery. We have turned the corner on both fronts, but the key test will be whether the rebound in people and capital flows coming out the pandemic returns to pre-pandemic levels or better.
Australia Q3 output and NGDP gaps
With the release of the Q3 national accounts, we can update our gap measures based on the Kamber, Morley and Wong modified Beveridge-Nelson filter. The output gap comes in at 1% of GDP, down from 1.2% in Q2. The NGDP gap is 3.9%, down from 5% in Q2. This is a reflection of the sharp decline in the terms of trade, although still a welcome sign of moderation in excess demand pressures;
As Martin Whetton points out, Australia remains an outlier in the steepness of its swap curve:
You could interpret that a number of ways, but it points to value on a relative basis (my interpretation, not necessarily Martin’s).
Menzie Chin estimates a probit model of Australian recession probabilities based on the AUD 3m-10yr spread and finds it a statistically significant predictor of recession, although I disagree with his interpretation that the spread does not call previous downturns:
As far as the Australian labour market is concerned, we are in Bob Lucas’s world now:
US November non-farm payrolls
US November non-farm payrolls came in at 263k, stronger than the market expectation of 195k, but closer to our expectation of 230k. The unemployment rate was steady at 3.7%, which was in line with our own and the market’s expectation. As we suggested in our preview, the continued strength of the labour market is a knock to sentiment on a Fed pivot, but the labour market is unlikely to front-run other indicators in pointing to a moderation in the pace of Fed tightening. Menzie Chin has a good piece on the apparent divergence in the establishment and household survey measures of employment.
ICYMI
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Memes and themes:
Isn't Philip Lowe taking instructions from the IMF, BIS; he is not original in his interest rate manipulation as overseas central banks are doing similar within a point or so.