THE BIG PICTURE: Why the RBA will need to wait to see how the floods play out

Humans like to think that they control most things. Then along comes a natural disaster like a flood and it reinforces the fact that there are many things outside our control – especially the weather.

While it was clear last year that the La Nina weather event would be significant, there was little that Australians could do to prepare. We didn’t know when the rain would fall, what centres would be most affected and how much rain would fall. Certainly the Brisbane Lord Mayor warned of the risk of a repeat of the 1974 floods in October last year, but the extent and timing of the rainfall was still a very open question.

No one wants to see floods occur and the effects are painful and sometimes tragic. But Australians are used to hardship. It is a case of enduring the event and cleaning up afterwards.

As we noted last week, estimating the impact of the floods on the economy can prove to be a moveable feast. The flooding didn’t stop in Rockhampton but spread through south-east Queensland. And there is still the prospect of further flooding in other parts of the country, with other significant rain events possibly occurring over the coming days.

The industries most affected are coal, transport, agriculture, tourism, insurance and construction. But the effects vary in magnitude, geography and across time. In general the short-term impact on the economy is negative with business activity and exports curtailed. But effects vary. While coal production in Queensland has been curtailed, producers in NSW are able to meet some of the shortfalls. And coal prices are rising in response to the tighter global conditions.

Infrastructure has been damaged and that poses costs for individual companies and the Federal Government. Companies will draw on insurance claims for the cost while the government will need to decide whether to soften its commitment on returning the budget to surplus or cut spending in other areas.

It’s important to note that the Federal Government has allocated $577 million this financial year for natural disaster relief and $80 million in each of the three following years. But it also has a contingency reserve to draw upon. Over the next three years the cumulative total of the contingency reserve stands at $11.4 billion.

How will the Reserve Bank respond? It will need to stay on the interest rate sidelines until the full impact of the crisis becomes apparent. In fact, financial markets see a small chance of a rate cut in the next few months.

With global media focusing on the severity of the Australian floods, the Aussie dollar has come under pressure. This is a knee-jerk response but will prove beneficial to tourism operators and exporters. And it’s important to note that global investors had already started shifting from the Aussie to the Canadian dollar before the floods.

The week ahead

There will be a marked shortage of “top shelf” indicators to be released in the coming week. But given how weak the latest results have been, probably that’s no bad thing. In the US the focus will be on housing activity indicators. And China should report its monthly economic data together with the economic growth estimate for the December quarter and 2010 year.

In Australia, lending finance kicks off proceedings on Monday together with car sales and the latest inflation gauge from TD Securities. Lending probably remained weak in November but car sales rose by 1.5% in December and the inflation gauge should be characterised by retailer discounting and higher petrol prices.

On Tuesday the Bureau of Statistics (ABS) plans to release a long-run series on alcohol consumption. Australians have been trimming beer consumption for some time, the question being whether the latest data confirms that consumption has fallen to 60-year lows as previous estimates implied.

On Wednesday the ABS and Federal Treasury release their latest estimates on wealth, and courtesy of higher housing and share prices, there are reasons to be happy. Data on imports and engineering construction are released the same day.

On Thursday the usual bevy of long-run labour market statistics will be released, allowing analysts to work out what’s really going on. Unfortunately only a relative few are prepared to trawl through the data. Figures on building activity are released the same day.

And on Friday the ‘inflation reporting season’ gets underway with latest figures on export and import prices.

In the US, the week begins with the Martin Luther King holiday on Monday with government offices and financial markets all closed.

On Tuesday, the Empire State manufacturing index and capital flows data is released.

On Wednesday the December housing starts estimates are issued. Over the past two years, annual starts have hovered between 500,000-600,000 and a result near 550,000 is tipped for December. Clearly no real growth can occur until the excess of stock is cleared.

On Thursday data on existing home sales, leading indicators, the Philadelphia Fed index and weekly jobless claims are expected. The leading indicator is tipped to lift by 0.7% after a 1.1% rise in November. And existing home sales may have risen by around 3%.

In China, monthly economic indicators such as retail sales and production are likely to be released on Thursday, together with the December quarter GDP figures.

Sharemarket

The US earnings season is underway. And while only a sprinkling of companies have reported so far, the list will grow over the next fortnight and reach a peak late in January. Overall, analysts surveyed by Thomson Reuters tip solid results with consensus forecasts centred on a 32% lift in earnings per share for S&P 500 companies. However, the gains will be fuelled by massive growth in the financial sector. Excluding financials, analysts tip earnings to rise by 11.1% with materials and energy expected to record the strongest gains.

Among companies reporting on Tuesday are Charles Schwab, Citigroup, Apple and IBM. On Wednesday a bevy of financial companies report including Bank of New York, Goldman Sachs, State Street, US Bancorp and Wells Fargo while eBay reports the same day. On Thursday Morgan Stanley, Advanced Micro Devices and Google are slated to release earnings. And on Friday General Electric is among those to issue results.

Interest rates, currencies & commodities

In 2010 the Aussie dollar was the second strongest currency in the world behind the Mongolian tugrik. But as is often the case, last year’s winners can quickly become next year’s losers, and that certainly does appear to be playing out at present. Early on New Year’s Day in Sydney (11am New York) the Aussie dollar scaled a 28-year peak of US102.5 cents. But from that point it was all one-way traffic lower for the Aussie. It was almost as if the high point signalled that time was up for our currency, with investors starting the search for the currency that would be the darling of 2011.

And it appears that investors have decided that the NZ dollar and Canadian dollar will replace the Aussie at the top of the tree in 2011. The Aussie peaked earliest against the Kiwi, hitting NZ$1.35 on December 23 and has since retreated by 4%. And the Aussie hit highs of C$1.02 at the start of the year, again receding by just over 4% in the period since. Investors seem to be of the belief that Canadian and New Zealand economies have more upside potential in 2011 than the Australian economy. Certainly given the weak Aussie economic data since the start of the year, the view has a reasonable basis.

It is certainly amazing how swiftly views can change, and that also applies to the interest rate market. Current pricing on the overnight index swap rate market is that there is a 6% chance of a rate cut at the February Reserve Bank Board meeting. A rate hike is now not fully priced into the OIS market in 2011.

Craig James is chief economist at CommSec.