RBA holds rates for another month …… though the next move may be down

As expected Reserve Bank holds rates steady, but adopts an easing bias

As expected, the Reserve Bank Board decided to leave rates unchanged at
4.75% at its October meeting.

However it is our assessment that the Board has now adopted an easing bias.
This is in sharp contrast to discussing the possibility of raising rates as
recently as the August Board meeting. The key to the easing bias has been
an improved outlook for inflation partly as a result of the downward
revision to the June quarter measure of underlying inflation and partly due
to evidence of softening demand. The key sentence in the statement is “an
improved inflation outlook would increase the scope for monetary policy to
provide some support to demand, should that prove necessary.”

That does not mean that the Bank is committing to a rate cut at its next
meeting in November. However, it does indicate that the inclination is now
towards cutting rates. Our view is that typically central banks do not
raise the prospect of lower rates without a strong body of evidence to
support a cut. That key sentence however is not as strong as we saw in
August 2008 when the beginning of the 2008/09 rate cut cycle was signalled
with “On these considerations, a case could be made for an early reduction
in the cash rate.” Accordingly, rates were cut by 25bps at its September
meeting which predated the Lehman Brothers collapse.

The overall commentary in the statement did not indicate to us that an
easing bias was eventually going to be adopted near the end.

Economic conditions were described as soft in both Europe and the United
States and the overall commentary on the Europe/US situation was not
particularly more down-beat than in September.

We were surprised that the recent turmoil in Asian financial markets was
not given more consideration with the theme which we saw in September being
retained, i.e. “It will take more time for evidence of any effects of the
recent European and US financial turbulence on economic activity in other
regions to emerge.”

On the domestic front, the observation made in September that the near term
economic outlook was not as strong as earlier expected was retained but in
contrast with the September statement, where the medium term outlook was
expected to be at trend or higher no commentary was given on the medium
term this time. The commentary on inflation was significantly more
confident than in September. This would partly reflect the downward
revision by the ABS of the underlying measure for the June quarter from
0.9% to 0.6%. The Board is now entertaining the view that the weaker
economic conditions are likely to contain inflation pressures with the path
for inflation now being more consistent with the 2-3% range for 2012 and
2013. The September quarter inflation print which will be released on
October 26 is now assessed as being very important for the inflation
outlook and the policy decision.

Other domestic data was generally softer with labour market conditions
being described as “now a little softer” and the Westpac-Melbourne
Institute Index of Unemployment Expectations getting some indirect
recognition with “households more concerned about the possibility of
unemployment rising.” Financial conditions are described as easing somewhat
due to slightly lower fixed interest rates which are, ironically, possible
due to the market predicting rate cuts, and of course the recent fall in
the exchange rate. However, it is still recognised that credit growth is
low and asset prices have declined.

Conclusion
Back on July 15 Westpac predicted a 25bp rate cut by December 2011. That
was despite all other economic forecasters which contribute to the
Bloomberg poll predicting rate hikes. The evidence from today’s statement
is that a cut as early as November is very much on the cards although a low
read on inflation, which is Westpac’s forecast, will not necessarily lock
the Bank into a cut in November given its emphasis on demand conditions.
With that in mind we are content to retain our December call whilst
recognising that the chances of November have increased substantially.

Reprint by Westpac Institutional Bank 4/10/2011

The RBA Statement in full:

Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to leave the cash rate unchanged at
4.75 per cent.

Conditions in global financial markets have continued to be very unsettled,
with uncertainty increasing about both the prospects for resolution of the
sovereign debt and banking problems in Europe, and the outlook for global
economic growth. While temporary impediments that had contributed to a
slowing in growth in some countries over recent months are lessening,
recent data suggest a continuing period of soft economic conditions in both
Europe and the United States. Moreover, the uncertainty and financial
volatility have reduced confidence, which could result in more cautious
behaviour by firms and households in major countries.

It will take more time for evidence of any effects of the recent European
and US financial turbulence on economic activity in other regions to
emerge. Thus far, indications are that economic activity is continuing to
expand in China and most of Asia. Nonetheless, recent events have led
forecasters to reduce their estimates for global GDP growth, which is now
expected to be about average this year and next. Prices for commodities
have declined over recent weeks, though in general they remain high.

Australia’s terms of trade are very high, which has increased national
income considerably. Investment in the resources sector is picking up very
strongly and some related service sectors are enjoying better than average
conditions. In other sectors, cautious behaviour by households and the
earlier rise in the exchange rate have had a noticeable dampening effect.
The impetus from earlier Australian Government spending programs is now
also abating, as had been intended. While there remain good reasons to
expect solid growth over the medium term, the indications are that the pace
of near-term growth is unlikely to be as strong as earlier expected, due
both to local and global factors, including the financial turmoil and
related effects on business confidence.

Underlying inflation stopped falling and began to increase earlier this
year. The Board has been concerned about the prospect of a further pick-up
over the period ahead, but over recent months has been weighing the
question of whether a period of weaker than expected conditions would
contain that pick-up in inflation. Recently revised data show a pick-up to
date in the underlying pace of price rises that was less sharp than
initially indicated. Moreover, with labour market conditions now a little
softer and households more concerned about the possibility of unemployment
rising, the likelihood of a significant acceleration in labour costs
outside the resources and related sectors is lessening.

Taking into account all the recent information, the path for inflation may
now be more consistent with the 2–3 per cent target in 2012 and 2013,
abstracting from the impact of the carbon pricing scheme. This assessment
will be reviewed on receipt of further data on prices ahead of the Board’s
next meeting. An improved inflation outlook would increase the scope for
monetary policy to provide some support to demand, should that prove
necessary.

The Board noted that financial conditions have been easing somewhat, with
interest rates for some housing and business loans declining slightly due
to increased competition and the fall in some funding costs in financial
markets. The exchange rate has also declined from the very high levels of a
few months ago. Credit growth remains low, however, and asset prices have
declined.

At today’s meeting the Board judged the current cash rate remained
appropriate. As always, the Board will continue to assess carefully the
evolving outlook for growth and inflation.

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