How many commentators, economists and others will heed the messages yesterday from the markets, the Standard & Poor’s downgrade of Italy, the Reserve Bank board minutes for the September 6 meeting and the IMF’s latest World Economic Outlook? There’s a lot to get heads around, and it’s not as simple as many observers are telling us. And it’s not as gloomy as the atmosphere pervading much of today’s coverage.
On the IMF, the morning papers in Australia went the headless chicken route. Take the Fairfax broadsheets with the parochial angle: “The International Monetary Fund has slashed its economic forecasts for Australia, warning of a new global recession that would hit commodity prices and drive millions worldwide into unemployment.”
The Australian growth figures, “slashed” to 1.8% this year from 3%, are understandable given the IMF has not updated its forecasts until now to take full account of the longer than expected impact of the floods in Queensland on growth. That’s old news. But the cut to 2012 growth to 3.3% from 3.5% is not exactly a “slashing” of the previous forecast. It’s still strong and big pick-up from this year.
And, by the way, to actually get to 1.8% for the full 2011 year we will need growth running at 0.8% or better over the next two quarters, which is an annual rate of more than 3%. Again, hardly a “slashing”.
Then there was The Australian, which normally goes the henny penny route but instead went global (perhaps Michael Stutchbury was too busy penning his explanation for why Wayne Swan shouldn’t have got the Finance Minister of the Year gong):
“The recovery from the global financial crisis has stalled and the world economy faces increasing danger of turmoil and recession, the International Monetary Fund has warned. But the Australian economy has more scope to adjust than most countries, with the ability to slow its return to budget surplus if conditions get worse, and it will be buttressed by the continuing strength in Asia, the fund says.”
And The Oz and some papers overseas, such as The Financial Times, picked up on the most important message from the IMF document: that it missed the slowdown this year completely. The IMF’s chief economist, Olivier Blanchard, admitted in the foreword to the outlook that he had misread the severity of the slowdown. He admits the “much slower recovery in advanced economies since the beginning of the year” was “a development we largely failed to perceive as it was happening”.
Given that miss, you’d be entitled to wonder about the new forecast, wouldn’t you?
Then there were the RBA board minutes, wherein the central bank carefully explained for anyone interested why Australian bond yields have fallen and why that doesn’t mean a rate cut is looming because of weak domestic demand. One wonders if it’s a message to commentators like Westpac’s Bill Evans and others who have been downbeat about the domestic economy for months. In the minutes the RBA explained:
“Members were informed that, in Australia, market pricing prima facie pointed to expectations of large cuts in the cash rate by the end of the year, but a range of technical factors meant that market pricing might not be giving an accurate reading of the expectations in the current circumstances. The decline in government bond yields globally was reflected in the local market, with the 10-year yield reaching a low of 4¼ per cent in late August and the 3-year yield declining to as low as 3½ per cent. The spreads on state government debt widened sharply, as liquidity in that market deteriorated (though yields still declined in absolute terms). This reflected the fact that while there had been considerable buying of Commonwealth Government securities by offshore investors, particularly foreign central banks, those investors generally have a smaller appetite for state debt.”
In other words, Commonwealth bonds have been a “safe haven” and asset diversification purchase by foreign investors, such as central banks (nice to have that confirmation from our own central bank), which has helped drive down local bond yields — not the sharp fall in confidence that sometimes produces a fall in yields ahead of a recession or a slowing in the economy.
That is a very big difference, but one missed completely by many commentators distracted by the bleats of noisy local retailers and manufacturers.
And the RBA also had a helpful bit of background for those commentators hopping on the “dollar slumps” bandwagon (like this from yesterday). The dollar indeed dipped yesterday under $US1.02, to around $1.014, after the cut in Italy’s credit rating was announced. But then it went back over $US1.02, to make a mockery of the forecasts. It later traded up over $US1.0280 in US trading. The RBA minutes say:
“The Australian dollar traded through a large range, but was more stable than equity markets; this was in contrast to 2008, when the Australian dollar tended to move pari passu with movements in global equity prices.”
“The bank’s liaison suggested that a growing realisation that the exchange rate was likely to remain at a relatively high level was contributing to a re-evaluation of business strategies. In some cases this was leading to restructuring and even closure of facilities. However, in others it was prompting investment in new capital equipment to remain competitive, consistent with a pick-up in investment intentions in the manufacturing sector reported in the ABS capital expenditure survey.”
In other words, the dollar is more stable that many commentators suggest: it will trade in a big range because it is a safe haven in times of low risk aversion, and in more fraught times because of the solid nature of the Australian economy, low debt and sound government finances. The currency has a dual role.
And finally, buried in the Standard & Poor’s rating downgrade for Italy was a subtle warning for Australia, both at a federal and state level. Like its downgrade of the US rating — remember that — the S&P move on Italy was essentially driven by politics and debt. Debt is not an issue in Australia (except perhaps for Queensland). But politics is more of a worry at the federal level, with a minority government and a coservative party apparently happy to throw away the economic rulebook that has guided Australian policymakers for the last three decades. That could worry ratings agencies (and, yes, we know their miserable track record in the GFC) if the economy slows or government finances get out of control. This what S&P said in its rating statement about Italy:
“Under our recently updated sovereign ratings criteria, the “political” and “debt” scores were the primary contributors to the downgrade … what we view as the Italian government’s tentative policy response to recent market pressures suggests continuing future political uncertainty about the means of addressing Italy’s economic challenges. The downgrade reflects our view of Italy’s weakening economic growth prospects and our view that Italy’s fragile governing coalition and policy differences within parliament will likely continue to limit the government’s ability to respond decisively to the challenging domestic and external macroeconomic environment. With elections due in 2013, and the government’s parliamentary position tenuous, it is unclear what can be done to break the deadlock between these political institutions and the government.”
Let’s be clear — there’s plainly no chance of any downgrade in Australia given that explanation. But there is a big message that political instability is playing a larger part in S&P’s ratings than at any time previously. It’s a message to everyone in Canberra, and particularly those outside government who think they can have all care and no responsibility when it comes to sounding off about economic policy. S&P has said twice now that what you say and what you do will be taken into account in assessing ratings.
Australia’s rating is stable and high in the AAA group, but should the worst happen and China slow, or the current slowdown turn into a global slide in 20012, then perceptions of political stability in Canberra will become that much more important, especially if difficult decisions have to be made about spending and taxes.