Monday, 5 March 2012

RBA Leaves Rates Steady ... But For How Long?

The RBA left the cash rate unchanged at 4.25% but kept its view that inflation is and will be low enough to allow it to cut interest rates if demand conditions weaken further. 

The Statement from RBA Governor, Glenn Stevens, was very dovish.  Indeed, the words are more aligned to the announcement of an interest rate cut than to leaving rates steady.

Below are a few extracts from the RBA and you make up your own mind whether the cut should have been delivered or not.  My comments are in the square brackets and italics.
  • “Recent information is consistent with the expectation that the world economy will grow at a below-trend pace this year.”  [This is the most important driver of the Australian growth and inflation momentum.  Below trend growth would normally mean below average interest rates.]

  • “Commodity prices declined for some months and are noticeably off their peaks, but over the past couple of months have risen somewhat and remain at quite high levels.”  [This is big news as lower commodity prices, especially in Australian dollar terms, eat away national income and corporate profits.  It supports the case for lower rates.]

  • “Europe will remain a potential source of shocks for some time yet.”  [Agree.  Should the RBA consider an insurance rate cut?.]
  • “Financial market sentiment has continued to improve in recent weeks and capital markets are again supplying funding to corporations and well-rated banks, albeit at costs that are higher, relative to benchmark rates, than in mid 2011.”  [This is one reason why the RBA did not cut.  Maybe it is of the view that these improvements in credit conditions will continue, in which case we could see the banks cutting retail rates outside RBA action.]

  • “Most information on the Australian economy continues to suggest growth close to trend overall.”  [Close means a little below, not a little above trend.]

  • “Labour market conditions softened during 2011 and the unemployment rate increased slightly in mid year, though it has been steady over recent months.”  [What happens to the most lagging of lagging indicators – unemployment – needs to move before the RBA does.  This is very reactive.]

  • “CPI inflation has declined as expected and will fall further over the next quarter or two. 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. This forecast embodies an expectation that productivity growth will improve somewhat as a result of the structural change occurring in the economy.”  [A great acknowledgment from the RBA about a lift in productivity.  If sustained, this will lower inflation and interest rates in a structural sense.]

  • “Credit growth remains modest.”  [Borrowing is weak.  Does this reflect the fact that interest rates too high?]

  • “Housing prices have shown some sign of stabilising recently, after having declined for most of 2011, but generally the housing market remains soft.”  [I remain perplexed about the reference to house prices stabilizing when they are lower now (February) than at any time in 2011.]

  • “The exchange rate has risen over recent months, even though the terms of trade have declined.”  [This means the AUD is overvalued and hurting the economy as a result.  While a rate cut will not automatically see the AUD fall, it would help take some of the froth out of what looks to be the start of a market bubble.]

So all up, I think it is clear, that there remains a good case for at least one arm of policy to move to an accommodative stance.  With the Budget a tight as a drum and the Australian dollar overshooting relative to fundamentals, it is pretty clear that monetary policy has the flexibility to do the lifting.  This is why the RBA is on track to cut a few more times over the months ahead and more monetary policy to an easy stance.  The cash rate target for me remains 3.5% although it is more likely to reach this level in the latter part of 2012 rather than mid year, as I previously thought.

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