by
Dr Stephen J Nash | Nov 07, 2012
Unexpectedly, the RBA left the cash rate unchanged at 3.25%. While expectations of an imminent rate cut were not realised, we expect one further rate cut by the end of the calendar year, as the business leaders on the RBA board factor in the higher Australian dollar, and the depressing impact the dollar is having on the export sector. Specifically, scope for even more easing, than currently expected, might emanate from global developments, especially in Europe, where risks remain significant yet very difficult to predict. Also, further detail on RBA thinking, especially on inflation, which seemed to be of some concern to the RBA, will be released on Friday, with the Statement of Monetary Policy (SOMP).
Despite this failure to ease, rates remain low, and the yields on term deposits and longer term debt remain attractive, especially when 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 on global growth seemed to reflect some stability in terms of global growth forecasts, “Global growth is forecast to be a little below average for a time. Risks to the outlook are still seen to be on the downside, largely as a result of the situation in Europe, where economic activity is still contracting. Risks elsewhere seem more balanced”.
- Financial market developments: In general, the assessment of financial market developments was largely unchanged from the prior statement. 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”
- Domestic economic developments: In general, the RBA summarised domestic conditions by noting that growth “has been running close to trend”. They commented that some of the growth had been “led by very large increases in capital spending in the resources sector”. They expect peak expenditure to occur next year and “will be at a lower level than expected six months ago”.
- Inflation: On inflation, the RBA commented that “inflation had been slightly higher than expected, though it was still consistent with the medium term target”. The introduction of the carbon tax affected the consumer prices in the September quarter and small increases are expected in future quarters. The RBA also commented as follows,
With the labour market having generally softened somewhat in recent months, and unemployment edging higher, conditions should work to contain pressure on labour costs in sectors other than those directly affected by the current strength in resources.
- AUD: The RBA noted that the currency remains “higher than might have been expected, given the observed decline in export prices and the weaker global outlook”.
The RBA commented that “Interest rates for borrowers have declined to be clearly below their medium term averages and savers are facing increased incentives to look for assets with higher returns. While the impact of these changes takes some time to work through the economy, there are signs of easier conditions starting to have some of the expected effects. With more recent information on the world economy slightly more positive, the Board judged that the stance of monetary policy was appropriate for the time being”.
Other factors
Markets have become overly optimistic, in terms of equity pricing, with the long awaited QE3. However, the recent earnings season is gradually bringing the equity market back to a more a realistic position, meaning equity prices have further downside. Gradually, the US bond market is now delivering what the Fed wants; the provision of lower, longer term interest rates. A target of 1.25% on the US 10 year is feasible, and with a possible spread of 1.25 to the AUD 10 year, there is still plenty of room for the Australian 10 year bond to rally from 3%. Recent declines in commodity prices and cancellation of mining expansion projects have already partly enabled a rate cut, and one more rate cut is possible this calendar year.
Conclusion
As we observed with the recent RBA minutes, financial market commentators are quick to overstate changes in RBA rhetoric; they have a habit of “jumping at shadows”. While we expected an easing this time, timing individual RBA rate decisions is subject to a large degree of error, and we still think an easing in December remains a possibility. What partly drove our assessment towards the expectation of an easing yesterday, was a recognition of ongoing labour market weakness, which the RBA has recently highlighted.