The RBA forecast that the RBA doubts

Reserve Bank governor Glenn Stevens … quietly hoping the dollar will fall.The curious thing about the Reserve Bank forecasting economic growth will remain stuck at its present level for 18 months is that the RBA itself probably doesn’t believe it.
Nanjing Night Net

Friday’s quarterly statement on monetary policy is a rich source of economic perspective, but the forecasting part is built on assumptions that the RBA types don’t necessarily believe.

The headline news out of the statement was the RBA becoming more pessimistic about 2014. Three months ago, the bank thought our economic growth bottomed in the September quarter and would slowly but steadily pick up next year. The latest statement still has the economy bottoming last quarter, but the forecast is that that we’ll remain stuck on about 2.5 per cent GDP growth until the 2015 June quarter.

There were two reasons key reasons for downgrading the 2014 outlook: the RBA thinks resources capital investment will fall sooner than previously guessed; and the Australian dollar has appreciated since the last statement.

The RBA forecast is based on modelling which assumes the exchange rate will remain the same throughout the forecast period – which of course it never does. But if you’re running a model and the exchange rate is unforecastable, you have to technically assume something.

Thus, the RBA is forecasting growth stuck at 2.5 per cent if the Aussie dollar remains stuck at 95 US cents – which the RBA clearly hopes and suspects it won’t.

The forecast’s technical currency assumption was effectively downplayed by governor Glenn Stevens two weeks ago when he warned forex players about the likelihood of the Aussie falling. In his remarks to the Citi investment conference he enlarged on the RBA’s recent message that the Aussie’s level presently is more about American monetary policy than about ours.

“Surely the ‘taper’ will come,” said Stevens. “We should hope it will, since it will signal that the US economy is well established on a recovery track, and it will start to lessen some of the uncomfortable spillover effects unavoidably associated with the present set of policies.

“For some countries, including Australia, the beginning of a return to something resembling more normal conditions, in at least one major advanced country, would lessen some of the difficulties we face in our own policy choices.”

And while the markets were startled earlier this year at just the mention of tapering by the Fed, Stevens was more relaxed about what will happen when it becomes reality:

“For some other countries, this may see some resumption of the less welcome pressures seen earlier this year. The good news is that we have had a dress rehearsal of what the beginning of tapering will probably look like, so we have a sense of the pressure points, and there is now a window within which to address some of them. It would be wise for policymakers to use that window.”

The governor went on to issue a specific warning:

“The foreign exchange market is perhaps another area in which investors should take care. While the direction of the exchange rate’s response to some recent events might be understandable, that was from levels that were already unusually high. These levels of the exchange rate are not supported by Australia’s relative levels of costs and productivity. Moreover, the terms of trade are likely to fall, not rise, from here. So it seems quite likely that at some point in the future the Australian dollar will be materially lower than it is today.”

Stevens has been around too long to be silly enough to put any timing on a forex forecast – that’s a game for mugs – but as well as wanting to jawbone the Aussie down, it is a statement of fact that it’s most likely to fall.

Even while stuck with the assumption that the Aussie remains steady at 95 US cents for a couple of years, the quarterly statement itself raised an argument that the earlier-than-previously-expected fall off in resources investment could weaken the Aussie, as there will be less foreign capital being converted into Aussie dollars than previously expected.

So while it’s officially forecasting one thing, the RBA is sort-of saying that it really expects the Aussie to resume its decline at some stage and that will mean stronger economic growth than it’s forecasting. Or, as a more cautious central banker might put it, the risks are on the upside.

Forecasting the Fed is almost as bad as trying to forecast the Aussie, but last week’s strong US data has been enough to raise market hopes again. The outgoing Fed chairman is delivering a speech on Wednesday night, our time, and he’s being followed on Thursday night by his nominated successor’s confirmation hearings.

If not in the former, than in the latter “tapering” is likely to be discussed. Any sign of determination by the Fed to wind back the printing presses should shake the foreign exchange market – and the RBA’s economic modelling.

PS. At an IMF research conference in Washington on Thursday night, RBA assistant governor Guy Debelle mentioned the problems of exchange rates not following the usual fundamentals when the US is printing money. Debelle spelt out the difficulty of trying to discourage capital inflows:

“That has posed an interesting conundrum in Australia in recent years. We have been experiencing a ‘boom with gloom’. We have had the difficult balancing act of trying to tell foreigners that the economy is not as good as they think it is, so stop sending us so much capital, while at the same time trying to convince the locals that the economy is not as bad as they think it is.”

Michael Pascoe is a BusinessDay contributing editor.

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