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Licensee Economic Update – February 2015

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In summary

January proved to be an eventful but positive month for the global financial markets as shown in the positive returns in graph 1 below. In Australia, speculation about a cut in interest rates intensified through the month, especially after a journalist reported what appeared to be a behind-the-scenes message from the Reserve Bank. Factors contributing to the market expectations of a local rate cut included soft headline inflation in the December quarter, further declines in key commodity prices and interest rate cuts overseas. As things turned out, the Reserve Bank did cut the cash rate to a new record low of 2.25% on 3 February.

Overseas, the data from the US remained generally positive, especially from the labour market although some headline growth indicators showed more moderate readings than in recent months. Europe provided most of the international excitement with the Swiss National Bank abandoning its peg against the Euro, the ECB announcing a bigger than expected programme of quantitative easing and the Greeks electing a radical left-wing government intent on renegotiating its relationship with the rest of Europe. Although the market reaction to the election of the new Greek government has been relatively sanguine so far, there is a real chance of market stress and instability in coming months.

Figure 1: The oil price fell further in January while bond-sensitive equities did well

selected market returns Jan 2015


In January, speculation intensified that the Reserve Bank would move to ease monetary policy in order to support the Australian economy. Sentiment about this waxed and waned through the month. For example, the better than expected labour market figures for December dampened expectations of a rate cut somewhat. The number of employed persons rose a much stronger than expected 37,400 and the unemployment rate slipped from 6.2% to 6.1%. The ANZ job advertisements series also provided some positive news on the labour market, posting the seventh consecutive monthly increase. The ANZ described this as “an encouraging sign that labour demand is firming” while the overall conditions remain soft.

The December quarter CPI figures provided a mixed perspective with headline inflation falling to 1.7%, the lowest result since 2012. However, the underlying inflation rate of 0.7% in the quarter was higher than the market had expected. This promptly led to an unwinding of market-based expectations of an interest rate cut. Other data which supported the notion of a cut were the NAB’s Monthly Business Survey for December which showed further declines in a number of measures, some softer than expected figures on building approvals and further declines in commodity prices.

Figure 2: Core inflation towards the bottom of the Reserve Bank’s range

australia inflation

However the speculation really intensified towards the end of January when Terry McCrann published an article suggesting he had received information directly from the Reserve Bank that they would either cut interest rates immediately or move towards doing so in coming months. Financial markets reacted sharply to this with bond yields and the Australian dollar falling further. The $A/US$ rate briefly fell below 0.78. As things turned out, the Reserve Bank did cut the cash rate by 0.25% through 3 February, citing below trend growth and muted inflationary pressures as reasons contributing to their decision. The Board noted that although the currency had fallen noticeably, further declines would be helpful.

The Bank’s statement made no clear reference to the likelihood of further cuts in the cash rate but following most economists views, it would seem likely that there will be another 25 basis point cut in coming months. The Australian dollar immediately fell back through US$0.78 on the news.


Some of the data from the United States was also a bit softer, including the headline Institute of Supply Management Index {survey of over 300 companies} which came in at 53.5 in January after hitting a highpoint of 55.1 in December and this

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was a little lower than the market had been expecting.

The fourth quarter GDP figures were also lower than the market expectations, coming in at a 2.6% annualised rate after a 5% increase in the third quarter. However, the third-quarter figure was the strongest recorded since 2003 and it is not unusual to get some softness immediately after such a strong result.

However, the data from the US labour market continued to be quite positive. Another 252,000 jobs were added in December with the unemployment rate declining further to 5.6%. The improvement in employment was spread across a number of industries. Nevertheless, despite the improvements in the labour market, growth of wages remains relatively muted. Consumer sentiment rose further in January.

In its latest statement, the US Federal Reserve acknowledged the improving economic fundamentals as well as the softer rate of inflation. Chairman Yellen’s statements indicated that she will look through any dip in inflation in 2015 caused by lower oil prices but that the Fed will continue to tread carefully on the question of interest rate increases.


Europe was the focus of much attention in January with the election of a new government in Greece and the ECB’s announcement of a new Quantitative Easing programme. The QE announcement was bigger than had been expected and is welcome news given the further decline in European inflation rates. Deflation would seriously undermine not only European growth but also the work that still needs to be done to fix budget and debt problems across the region.

The Greek election produced the win for Syriza which had been expected, but with a bigger number of seats that had been expected. The questions now are how successful will the new government be in delivering on its promises to ease the debt and reform burdens on the electorate and how difficult will be the process of negotiating this with the rest of the Eurozone?

The early signs suggest things will be more difficult rather than less. Although Prime Minister Tspiras has made some more conciliatory comments about wanting to stay within the Eurozone, his Finance Minister and Foreign Minister have adopted much more belligerent stances in recent public statements. Notably, Greece seems prepared to chastise the rest of Europe on more than just economic matters and may provide an opportunity for Russia to try to disrupt the program of European sanctions against it.

The more fundamental and significant problem though is that Syriza has tapped into the mood of the Greek people that they are not responsible for the country’s economic difficulties. Rather, they blame the previous government and the international banks which lent them the money they could not repay.

Capitalists argue the extension of denying responsibility is denying the need for economic reform and the burdens that come with it. Add to this the ingrained dislike and mistrust which parties like Syriza have for capitalism, and the stage is set for some significant fights with the rest of the Eurozone.

Both sides can hold each other hostage. The Eurozone can threaten to withhold funding to the Greek banking system if Greece does not fulfil its obligations, while Greece can threaten to destabilise the Eurozone by exiting if it is not allowed to rewrite the rules in its favour. Greece will be hoping for support from like-minded left-wing political aspirants in Spain, but so far Portugal and Ireland seem to want to have none of it. The Germans see Greece as the thin end of the wedge for unravelling the necessary programme of reform across the continent. Furthermore, Germany and other nations risk significant internal political backlash if Greece is seen to be let off the hook.

Over the next few months Greece needs to either meet or renegotiate specific obligations with the Eurozone in order to retain its funding support. These will provide trigger points for increased market stress and uncertainty.

The Swiss National Bank rocked the currency markets when it announced it would abandon the peg against the Euro that it had been defending since 2011. This came ahead of the ECB’s announcement and was taken as a sign of further significant expected depreciation of the Euro which the SNB would be unwilling to resist. The Swiss franc rose sharply (up nearly 14% against the US$ at one stage) and the Swiss equity market fell by as much as 12% before recovering some losses.

This has been prepared by Paragem Pty Ltd [AFSL 297276] and is intended to be a general overview of the subject matter. The above is not intended to be comprehensive and should not be relied upon as such. We have not taken into account the individual objectives or circumstances of any person. Legal, financial and other professional advice should be sought prior to applying the information contained in above. Advice is required before any content can be applied at personal level. No responsibility is accepted by Paragem or its officers.

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