RBA Minutes - High AUD forces easing bias

In December, the RBA cut interest rates by 25bps to 3.00%, as the market expected. In the Minutes issued yesterday, the RBA continued to develop the more dovish tone that began in the September Minutes, as the high AUD playing havoc with the export sector. While markets want more easing than the RBA will deliver in the short term, the RBA appears set to move next year. Recent elevations in lending and improvements in the housing market, will, however, require careful assessment by the RBA. Hence, easing should come at a slower rate than the market expects.

This note provides a summary and comments on considerations for monetary policy and finally, some brief conclusions. The pertinent details from each section of the Minutes are provided below.

Global assessment

Overall, the assessment of global growth was slightly more upbeat over the recent months, with assessment that regional and Chinese growth has stabilised. As the RBA note,

Members noted that a range of data on the Chinese economy suggested that growth there had stabilised. Fiscal policy easing, including support for infrastructure spending, and improved conditions in the residential property market had supported growth in industrial production and demand for bulk commodities. Exports had continued to expand, particularly to the United States, following weakness in the middle of the year.

While growth in the US had improved modestly, the opposite occurred in the Euro area, while commodity prices remained subdued, as the RBA noted,

Members noted that, overall, global commodity prices were little changed since the previous Board meeting. Spot prices for coal had picked up slightly after falling over most of the year. Base metals prices had risen, while rural prices were little changed and iron ore prices had recorded a modest decline. The terms of trade fell in the September quarter and were likely to have declined further in the December quarter, to be around 15 per cent below their peak in 2011.

Even though the terms of trade had already peaked, the AUD remained “high” as the RBA note below, and the high level of the AUD remains a brake on domestic economic growth.

Domestic assessment

Even though the GDP data was not released at the time of the Minutes, the RBA indicated it expected growth would come in around trend, despite slowing in recent quarters, with a decline in growth partially attributable to a fall in public spending in the aftermath of the GFC. Further moderation in mining sector investment was also foreseen, as the RBA indicated,

The outlook for mining investment over the remainder of the financial year had been revised down in the ABS capital expenditure survey, largely confirming the outlook based on liaison and other information that had been incorporated in the Bank's most recent forecasts.

Non-mining sector activity was noted to be rather modest, with some indicators suggesting some weakness in the non-mining sector,

Investment outside the mining sector increased in the September quarter, although the capital expenditure survey suggested that there would be negligible growth, or even a small fall, in 2012/13 as a whole. Members noted that survey measures of business conditions had generally declined further and measures of capacity utilisation were a bit below average, with the Bank's liaison suggesting that some firms were investing only to cover the depreciation of existing capital. Members noted that there was also concern in the non-residential construction industry about the modest pipeline of work once the existing wave of committed resource projects was completed. While growth in credit to unincorporated businesses continued at a measured pace in recent months, growth of business credit overall had slowed.

In other words, both mining and non-mining sectors were facing only very modest growth prospects, and the high level of the AUD was impacting the export sector. In the statement that accompanied the recent easing on December 4, the RBA noted that while some of the expected impacts of the recent easing cycle were beginning to show through, the AUD remains higher than expected. As the RBA noted,

There are signs of easier conditions starting to have some of the expected effects, though the exchange rate remains higher than might have been expected, given the observed decline in export prices and the weaker global outlook (RBA Media Release 2012-36, 4 December 2012).

Financial markets

Despite uncertainty about fiscal discussions in the US and the delivery of the Greek aid package, the RBA noted a relative calm in financial markets over the prior month. Moreover, the RBA noted that this calm was now allowing corporate bond issuance, as the RBA indicated,

Members observed that the primary markets for corporate debt globally were strong, with issuers benefiting from record low yields in many markets. Financial institutions generally had been less active issuers of debt securities in recent months. In Australia, issuance of bonds by corporates had reached a new high during 2012, as bond yields domestically also declined to record low levels. For the Australian banks, the focus remained on raising deposits, although there were signs that competition in some deposit markets was beginning to ease.

Significantly, the RBA noted that the AUD remained at a “high” level. Given the recent decline in commodity prices, the RBA would have expected that the AUD would be much lower than current levels. With growth looking modest at best, such a high currency represents a significant risk to growth, over 2013 and remains an ongoing significant concern for the RBA.

Considerations for monetary policy

Generally, the RBA indicated the global growth forecast had improved, although significant risks still remained. Domestic growth forecasts had been lowered as a result of the moderation in the demand for labour, suggesting that wages growth would remain contained, going forward. While an improvement in the global economy and a higher CPI reading constrained the RBA in November, softening labour market conditions allowed the RBA to further support demand, by easing monetary policy, as they indicated in the following,

At this meeting, the information on labour costs and softening labour market conditions suggested that the inflation outlook still afforded the Board some scope to provide additional support to demand. Further confirmation that the peak in resource sector investment was near, and that the short-term outlook for non-resource investment remained subdued, indicated that there was a case for the Board to provide that support. The Board considered whether to respond to this case in the near term or wait for further information. On balance, members saw merit in reducing the cash rate at this meeting.

Conclusion

In the Minutes released yesterday, the RBA indicated that it remained uncertain about the pace of growth in the domestic economy, in the wake of the recent moderation in mining related activity and under the influence of a high AUD.

While inflation remains somewhat less of an issue for the RBA, when compared to the November Minutes, a gradual softening of overall domestic growth remains a problem and cause for a heightened level of uncertainty, in the absence of continued mining growth. Accordingly, it can be argued that this uncertainty effectively leaves the RBA on an easing bias as the Minutes tend to suggest. At this point, further easing are expected over the calendar year of 2013, as the AUD depresses the export sector, yet only after more evaluation of the recent easing cycle is conducted by the RBA. We estimate that cash rates will average around 2.75% for 2013, and end the year around 2.50%, which means that investors will need to obtain better returns than cash in the fixed income markets.