Monday, 6 February 2012

RBA: You got to know when to hold 'em, know when to fold 'em...

The RBA has shocked the world by holding official interest rates steady at 4.25%. It is a surprise because the economy is growing a little below trend, inflation is low and falling, the labour market is softening and global conditions are problematic. Throw in a moribund housing market and a massive fiscal contraction and it’s hard to see why the cut was not delivered.  There may have been one or two super-hawks arguing against it when you read between the lines of the last paragraph of the RBA statement.

A surprise also because as we have seen, the already over-valued Australian dollar is about 1 cent higher at 1.0790 at the time of writing, despite a clear fall in global commodity prices. In AUD terms, the RBA’s own commodity price index has fallen 10% since August 2011. For those interested in the academic exercise of looking at monetary conditions indices, policy is tighter now than before the rate cutting cycle started in November.

Of course, all is not lost. The RBA meets again in 4 weeks and then every month through to December 2012. It can play catch up at any or all of these meetings. It probably knows it has to cut at some stage but it seemingly judged there to be no urgency. We’ll see how growth and confidence issues unfold in the weeks ahead and whether the RBA needs to play catch up.

In holding rates steady, the RBA notes [my comments in square brackets]:

  • “Information becoming available since the December meeting confirms that economic conditions in Europe were weakening late last year, with risks still skewed to the downside. Reflecting this, most forecasters have lowered their forecasts for world GDP growth this year to a below trend pace.” [RBA seems to be downplaying global risks and looking too much at mining and resources sector.]

  • “Information on the Australian economy continues to suggest growth close to [does this mean just below] trend, with differences between sectors. Labour market conditions softened during 2011 and the unemployment rate increased slightly in mid year.” [RBA does not mention employment or participation rate, other useful indicators of capacity constraints in the labour market.  Is this the right thing to do?]

  • “In underlying terms, inflation is around 2½ per cent. Over the coming one to two years, and abstracting from the effects of the carbon price, the Bank expects inflation to be in the 2–3 per cent range.” [Like last year, when the RBA badly misread the inflation outlook, it is stubbornly holding a view that inflation will be ‘high’.  It may well revise inflation lower but not till after the March quarter CPI in April.]

  • “Credit growth remains modest.” [Understatement!  A 34 year low for housing credit is modest indeed.]

  • “Housing prices showed some sign of stabilising at the end of 2011, after having declined for most of the year.” [Not sure which data it is using with one monthly rise out of the last 12 months.]
  • “The exchange rate has risen further, even though the terms of trade have started to decline.” [This is a disjunction made more extreme by the decision not to cut.  If the AUD keeps rising and commodity prices do not, we have a problem.]

  • “the Australian dollar in trade-weighted terms is somewhat higher than the Bank had previously assumed.” [This should mean that the RBA forecasts for growth and inflation should be lower than previously assumed - but they aren't for some other reason.]

  • “Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy. The Board will continue to monitor information on economic and financial conditions and adjust the cash rate as necessary to foster sustainable growth and low inflation.” [The RBA is moving from pre-emptive to reactive policy settings… fair enough but this is risky if it needs to catch up at some stage.]


  1. Could there be an element of leaning against the housing price bubble? By all accounts, it still has a way to go before it is unwound.

  2. something about Generals fighting the last war, but I couldn't really be bothered...