Deflation stalking markets. If you think the Reserve Bank’s surprise rate cut yesterday means we have a problem with looming deflation, take a look at what the European Commission said last night in its new forecasts for the eurozone economy. It revealed some hefty downgrades to its growth and inflation forecasts. It said it expects consumer prices to rise just 0.2% this year, down from 0.5% in February and 1% last November. That points to a persistently dovish European Central Bank and negative interest rates and big spending by the central bank for some time to come as they attempt to fight off deflation. That was after the Bank of Japan slashed its forecasts for inflation and growth for 2016-17 (down to a still optimistic 1.2% from 1.5%) and cut its core consumer inflation estimate (which excludes food) to 0.5% from 0.8%, which, based on previous monthly reports, implies no inflation at a headline level, or even slight deflation. Central banks in the US remain worried about weak inflation (the US inflation rate favoured by the Fed hasn’t reached its 2% target level for more than two years). Inflation is weak in China and the rest of Asia and a worry in NZ, so yesterday’s cut by the RBA is in good company. But it attracted worldwide attention and played a part in a global sell off overnight in markets. In fact investors singled out the RBA’s cut as one of the factors behind the global sell off. Marketwatch.com reported:
“Analysts noted that an unexpected interest rate cut by Australia’s central bank added to already gloomy sentiment. ‘A surprise rate cut by the Reserve Bank of Australia is probably an attempt to stop their currency from appreciating, but if all central banks do that, it’s a race to nowhere,’ said Colin Cieszynski, senior market analyst at CMC Markets.”
— Glenn Dyer
RBA between a rock and a deflation future. The RBA’s rate cut yesterday was, in effect, a decision in anticipation last night’s budget would not contain anything that would help monetary policy support the economy. As the AMP’s chief economist Dr Shane Oliver said in a comment on the budget last night, “There is insignificant fiscal stimulus.” And that seems to have been the unwritten bottom line from the from the RBA, overlain by the fears of deepening disinflation and perhaps the emergence of deflation in coming months. In a speech in New York late last month, Stevens made it clear that he saw the need for policies in addition to what central banks were doing with monetary policy (and he wasn’t talking specifically about Australia, but his comment was apposite in view of the contents of the budget):
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“It is surely time that policies beyond central bank actions did more in this regard. Our inability, so far, durably to lift growth prospects is arguably the biggest vulnerability the global financial system faces today. This needs to be our focus.”
Yesterday, the RBA cut the cash rate to a record 1.75% and Stevens said in his post-meeting statement in justification:
“Taking all these considerations into account, the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting.”
Accepting that this was before last night’s federal budget, it seems the RBA governor believes the central bank and monetary policy remain the only lever capable of achieving “sustainable growth in the economy”. The underpinning of the decision will be explained in more detail in Friday’s second Statement of Monetary Policy for 2016. But it is clear the bank sees the rising dangers of disinflation are greater than problems created by cutting rates to a record low, especially in housing. The big danger from the RBA’s point of view is that the slide to a negative reading for the CPI in the March quarter (annual inflation and core inflation remains low, but positive), thanks to intensifying disinflationary pressures, might push annual cost pressures closer to outright deflation. And that is a worldwide fear.
The fact that the Australian central bank, with a reputation for patience and caution moved so quickly after the March quarter CPI report and its shock fall in headline CPI, and the slide in underlying inflation to the lowest level ever recorded in that series, startled global markets last night and overshadowed any news of the federal budget. That is the real story from yesterday, not the melange of measures from Scott Morrison last night. The fear of deflation is stalking global economies and markets, and last night’s budget made no mention of that. — Glenn Dyer