by
Dr Stephen J Nash | Sep 06, 2012
As expected, the RBA statement yesterday indicated that the cash rate was to be left at 3.50%, and the market was very interested to gauge RBA reaction to recent declines in the resource sector, as indicated by declining commodity prices. Expectations of an imminent rate cut were dashed and we expect no rate cut by the end of the calendar year, as the domestic economy does not require further stimulation at this time, in the absence of a new European calamity. Scope for further easing now seems very much tied to global developments, especially in Europe, where risks remain significant yet very difficult to predict.
Despite this current easing, the yields on term deposits and longer term debt remains attractive, especially given corporate debt is returning more than double the government rate in most cases
Statement
The following points are evident from the statement:
- Global growth comments were moderated from the prior statement in August 2012, yet not as much as the market had expected. Regional growth is now at a more “sustainable pace”, as the RBA indicates
Having picked up in the early months of 2012, growth in the world economy has since softened. Current assessments are that global GDP will grow at no more than average pace in 2012, with risks to the outlook still on the downside. Economic activity in Europe is contracting, while growth in the United States is only modest. Growth in China remained reasonably robust in the first half of this year, albeit well below the exceptional pace seen in recent years. Some recent indicators have been weaker, which has added to uncertainty about near-term growth. Around Asia generally, growth is being dampened by the more moderate Chinese expansion and the weakness in Europe
- Financial market sentiment was acknowledged to have improved, with some resolution to European concerns expected. As the RBA indicated, “Financial markets have responded positively over the past couple of months to signs of progress in addressing Europe's financial problems, but expectations for further progress are high”
- In general, the RBA summarised domestic conditions by noting that growth, “has been running close to trend”. While the current level of unemployment remains “low”, the assessment of inflation was quite positive, where inflation was seen to remain in the target band, despite the impact of the carbon tax, however challenges were evident
- Once again, as the exchange rate falls, the RBA emphasised, as it did in July 2012, that there may be some pressure on inflation. As the RBA said last month, maintaining low inflation will be a challenge as the impact of the higher AUD wanes. However, this month, reference to the “long term” was dropped, so the problems for maintaining low inflation were effectively brought forward. Specifically, the RBA said this month,
“Maintaining low inflation will, however, require growth in domestic costs to remain contained as the effects of the earlier exchange rate appreciation wane”. Whereas last month the RBA said,
“Maintaining low inflation over the longer term will, however, require growth in domestic costs to continue their recent moderation as the effects of the earlier exchange rate appreciation wanes” (August Statement)
- Importantly, the RBA signalled that the current stance of monetary policy remains appropriate given that “a more subdued international outlook” existed, much as it summarised last month.
Other factors
Markets are still pricing in QE3 with elevated equity pricing and low bond yields, and there is some more of that to come, as we move through September. Domestically, recent declines in commodity prices, and cancellation of mining expansion projects is lifting expectations of a rate cut, in addition to the buoyancy created ahead of forthcoming quantitative easing by the US Fed. Given that the main concern of the RBA on inflation may be fading, the market is now firming towards lower rates. However, in the statement, the RBA continues to tell us, as they have repeatedly, that rates are now low relative to history, while unemployment remains low, so the potential for an inflation breakout remains apparent, especially given the carbon tax and the potential for the currency to add to inflation over time.
Conclusion
Yesterday, the RBA did two things. First, it did not ease, as expected. Second, it did not do what the market expected; it did not skew expectations towards an imminent easing of policy. Rather, the RBA did what it has done for the last few months; it left interest rates unchanged and it indicated that policy is now driven by global risk factors. In general, the statement was much more neutral than the market had expected, leading to slightly higher interest rates and slightly higher levels in the AUD. References to inflation threats were delicately nuanced towards the short term, from the longer term. Looking forward, the scope for further easing in monetary policy is becoming more limited, with a maximum low target of around 3.25%, by the end of the year looking more likely. More and more, the risks seem to be firming towards unchanged policy for the rest of the calendar year, in the absence of a calamity in Europe.