RBA Minutes - Now more open to rate cut

In September, the RBA chose to do what the market expected once more, it left rates unchanged, and continued to identify that the stimulus for further easing was probably going to come, if at all, from offshore. However, in the minutes issued yesterday, on 18 September (the Minutes) for the 4 September meeting, the RBA shifted away from the more hawkish tone in August, as initially sketched on 3 July and 7 August. While markets want more easing, the RBA is still not so sure, but is now much more neutral on the subject, when compared to August minutes.

Once again, the order of topics suggests that the RBA continues to be somewhat relaxed, since it has reverted to the usual ordering of topics, with global developments being dealt with first, unlike the June minutes, where developments in financial markets were dealt with first.

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

While expansion in growth was apparent in the United States, European growth “remained weak”. Of most interest, however were the RBA comments on regional growth, especially Chinese growth. Here, the RBA acknowledged that activity in China as a “little softer overall”, and the comments on the impact of the weakening on commodity prices was most interesting,

Members observed that spot prices for iron ore and coking coal had fallen sharply of late, largely reflecting weakness in China's steel market as well as an easing in a range of factors that had temporarily disrupted the supply of coking coal. Since mid June, iron ore spot prices had fallen by a little over 35 per cent and coking coal prices had fallen by almost 25 per cent. Members noted that these price falls were likely to be reflected relatively quickly in export prices, as an increasing share of iron ore was traded in the spot market and on short-term contracts over recent years. Overall, other commodity prices had been relatively flat over the past few months. The RBA index of commodity prices had declined by 7 per cent over the previous month (on the basis of spot price movements).

Domestic assessment

Significantly, the RBA emphasised the current low level of observed inflation, and indicated that it does not think that there has been much upward influence on the CPI from the Carbon price, even though wages were a little elevated in the June quarter. As the RBA indicate,

Liaison suggested that the introduction of the carbon price had not yet had a significant effect on downstream price pressures, with only isolated examples of suppliers attributing price increases to the carbon price.

However, two main problems exist for those wanting rates lower, as they did in August. First, unemployment remains very low by historic standards, although leading indicators pointed to a softening in the labour market. Second, interest rates remain a little below average. In other words, the ability of the economy to withstand any increase in growth remains limited. Yet, the point, in these minutes, is that acceleration of growth remains unlikely with the moderation in commodity prices, as the RBA indicate,

If the fall in the iron ore and coking coal prices were to be sustained, it could lead to somewhat lower mining investment, but given the large LNG and other mining investment projects already under way, the staff still expected there to be a substantial increase in resource investment over the next year or so.

Financial markets

Even though the RBA minutes pre-date the ECB announcements, the RBA note the improvement in expectations in the lead up to the recent announcement by the ECB. While equity prices had lifted in most markets, the RBA noted that this was not the case with a large trader partner, China, where the equity market was “at its lowest level in more than three years”. Since the currency remains a drag on growth, the comments by the RBA, especially about the possible over-valuation of the currency were of great interest, 

Activity in foreign exchange markets was also subdued in August, with the euro appreciating modestly. While the Australian dollar depreciated slightly over the past month, it remained near its recent highs, despite significant falls in some commodity prices and a weaker outlook for the global economy. Members noted that most model-based estimates of the currency generally placed a large weight on the terms of trade. With the terms of trade still high by historical standards, these models suggested that the Australian dollar may have been somewhat overvalued, but not substantially so, although members also noted the significant uncertainty that surrounded this assessment.

While these models may have been relevant in the past, two main recent developments are keeping the AUD at elevated levels: (a) the relative yield of the AUD, relative to the developed world, (b) the relative credit quality of the Australian government, to the rest of the developed world. Also, improvements in AUD liquidity support and amplify these two recent developments.

Financial stability

Here the RBA emphasised how risks to global financial stability remain significant, while Australian banks remained strong enough to weather potential volatility,

In general, the Australian banking system remained well placed to service the needs of the Australian economy. Members noted that pressures in wholesale funding markets had eased since late last year and the large banks had further reduced their use of offshore wholesale funding as growth in deposits continued to outpace growth in credit. While the Australian banks remained exposed to swings in global financial market sentiment associated with the problems in Europe, the changes in their funding, liquidity and capital positions over recent years suggested their resilience to these swings had improved.

Considerations for monetary policy

Generally, the RBA indicated that the Australian economy was recording a trend level of growth, while global economies continued to pose serious risks to achieving that expected level of growth. However, the RBA did what the market thought that it might do last month; it acknowledged the recent declines in bulk commodity prices. As the RBA indicate,

Developments since the previous Board meeting suggested that the global economy remained subject to significant downside risks. Of particular note this month was the recent sharp decline in some bulk commodity prices. At the same time, though, the domestic economy appeared to be growing at around trend pace and there were signs that the effects of earlier reductions in the cash rate were still working their way through the domestic economy.

Apart from the dramatic downside movements in commodity prices, the high Australian currency was also recognized by the RBA, as “weighing more heavily on the economy than might be expected”. Hence, the decline in commodities, when combined with the high currency are acting together to drag growth, possibly lower than trend, over the medium term.

Conclusion

Financial market commentators are quick to overstate changes in RBA rhetoric; they have a habit of “jumping at shadows”. An unbiased reading of the minutes, however, does indicate a new opening up of the possibility of a rate cut, in the absence of a problem CPI reading on 24 October. A November easing now remains a possibility, yet developments in many variables will need careful monitoring before that would occur. Specifically, while Europe remains the key risk for RBA expectations of growth, the high currency and the fall in commodity prices are shifting RBA thinking. While rates were not going anywhere in August, given borrowing rates are lower than average and low unemployment, recent developments are changing RBA assessments of domestic growth. While domestic considerations do not, on balance, require additional easing, the RBA has just lowered the bar with regard to what is needed for an easing of monetary policy. However, improvements in bank funding, where the five year senior bank funding spread had fallen more than 50 bps since January, may allow competitive pressures to create an easing in mortgage rates, without the RBA lifting a finger.