RBA Minutes - easing bias remains intact

International economic conditions assessment

Overall, the assessment of global growth was consistent with that given over the recent months, although the RBA did not mention that the overall trend in global growth was around trend, as it did in the prior minutes. Also, the comment on inflation was important, as it signifies that the RBA is noticing a decline in global inflationary trends,

...there had been a decline in inflation across much of the globe in recent months

While the US was seen as growing, evidence of weakening manufacturing was evident, which we have noticed in the series of Federal Reserve surveys. While Chinese growth was seen as “steady”, recent “controls” were seen as possibly weighing on growth in the short term. Japan, was noted to have picked up, offsetting, to some extent, a possible moderation in the pace of Chinese growth over the next few months.

Domestic assessment

While monetary policy had begun to get traction, where RBA liaison indicated an improvement in the outlook for dwelling investment, and the impact of low interest rates on the auction clearance rate was observed, along with the following points:

• subdued labour market, where RBA liaison indicates general caution, regarding employment growth had not been as fast as the growth in the labour force,
• consumption has strengthened, where the volume of retail sales was seen as having increased noticeably early in the year, but may have “eased somewhat more recently”,
• business sentiment and conditions were still subdued, meaning that firms were cautious about expansion in the context of a long and drawn out election campaign, and
• wages cost growth was generally seen as being well contained, and that ongoing fiscal constraints will maintain wage control in the public sector, although most falls in wages were observed in the private sector,

Importantly, the RBA noted growth was bellow trend:

The limited data for the Australian economy released over the previous month had been mixed, with indicators for the household sector generally remaining stronger than those for the business sector. With the March quarter national accounts scheduled for release the day after the Board meeting, members were briefed on the indicators that were available at the time of the meeting. These suggested that economic activity had grown at close to, or a little below, trend pace in the March quarter, consistent with growth over the year being a bit below trend. However, members noted that this estimate remained subject to the usual degree of uncertainty.

Financial markets

Markets were seen to be dominated by the recent announcement from the Bank of Japan and the prospects for a withdrawal of stimulus in the US. Of most importance, however, were the comments on the Australian dollar. As the RBA noted,

In foreign exchange markets, the US dollar had appreciated further against most currencies over the past month, with the Chinese renminbi a notable exception. The appreciation of the US dollar had mostly reflected changing expectations about US monetary policy. In that regard, an important contributor to the recent depreciation of the Australian dollar had been the US dollar's appreciation. Members noted, however, that the Australian dollar had depreciated against most currencies, reflecting further declines in commodity prices and market concerns about the outlook for China, as well as the reduction in the cash rate in May. Over the past month, the exchange rate had depreciated by around 5 per cent in trade-weighted terms and it was around 8 per cent below the historical high reached in early April.

While acknowledging the main influence on the Australian dollar was the strength of the US dollar, the RBA also pointed out that the Australian dollar had weakened even more than suggested by the rise in the US dollar. In other words, if the US dollar was to weaken again, especially if economic data in the US was to weaken, then the Australian dollar would rise again thereby presenting another problem for exporters. Hence, renewed weakness in US growth will be bad news for Australian exporters, as the decline in the US dollar that such weakness will inspire, could force the Australian currency back above parity.

Considerations for monetary policy

In the context of lower than expected domestic inflation, with sub-trend growth, the RBA still maintains that there is scope to ease monetary policy further. Transitioning from mining-led growth to non-mining led growth is the reason rates are low, and this transition will create the scope to ease policy even more by the end of the year. These observations, among others, are apparent in the final paragraph of the RBA minutes, which is noted as follows,

At this meeting, members viewed the current stance of monetary policy as appropriate for the time being. The Board also judged that the inflation outlook as currently assessed might provide some scope for further easing, should that be required to support demand ([emphasis added]).

Notice that the RBA uses the word “might”, as the provision of further easing depends on the evolution of data, although our estimate is that we expect that evolution to be broadly supportive of one further easing this year.

Conclusion

While monetary policy is now gaining some traction, the impact of lower rates is still seen as tentative and emergent by the RBA. Further lowering of rates looks like the most likely outcome, in order to support these emergent positive effects of monetary policy; to support the “green shoots” in the economy. Expecting more than one more easing may, at this time, appear to be too optimistic, assuming that nothing dramatic occurs on the global scene, in terms of growth perceptions.

Specifically, in the minutes released yesterday, the RBA indicated that the domestic economy is still expected to grow below trend and that the inflation rate outlook still remains very much contained, not only in Australia but globally. While the Australian dollar has declined, the RBA has pointed out that an “important” aspect of the Australian dollar decline is the appreciation of the US dollar. If that appreciation proves ephemeral, then the Australian export sector will be under more of the same pressure that it has experienced of late. Specifically, in the absence of unified Commonwealth Government plan for dealing with an elevated Australian dollar, the Australian manufacturing sector is facing a crisis; a crisis that comes at a time when the mining sector is slowing.

We estimate that cash rates will average around 2.75% for 2013, and by the end of the year, they should be around 2.50%, assuming current expectations of global growth remain intact. Moderations in perceptions of global growth may well lead the cash rate target much lower from that level; we have to await these developments.

Apart from other things, a cash rate that equals the medium term inflation rate will mean that investors need to obtain better returns, when compared to cash, in the fixed income markets so as to smooth turbulence from somewhat optimistic equity markets.