RBA Minutes - easing bias softened, yet still intact

Financial markets

In the July minutes, the RBA changed the order of topics, elevating the discussion of financial markets, ahead of discussion of global and domestic conditions.

Of some interest here was the discussion of the rise in global bond yields and the market perception of a change in US monetary policy. However, the acknowledgement of what was going on in China was of most interest, where authorities were seen to have become much more serious about reigning in credit growth

Another factor contributing to the volatility in financial markets was a tightening of short-term liquidity conditions in China. It appeared that the People's Bank of China was comfortable with some tightening in the interbank market to help rein in the pace of credit growth, particularly in the ‘shadow’ banking system where growth had been strong in the first half of 2013.

Also of interest, was the interpretation, taken by financial markets, that the depreciation of the Australian dollar will reduce the size and number of future easings.

International economic conditions assessment

Overall, the assessment of global growth was consistent with that given over the recent months, although the RBA did mention that it was carefully assessing what the tightening in financial conditions in China might mean for economic growth

Members observed that the data released over the past month were consistent with growth of Australia's major trading partners remaining around average. Monthly indicators of economic activity continued to point to steady growth of the Chinese economy, with stable growth in investment and ongoing demand for new housing. It remained too early to tell how long the tightening in financial conditions in China would be sustained and what its effect on borrowing and economic activity might be.

Also, the RBA acknowledged the continuing decline in commodity prices in USD terms, but not AUD terms, as the AUD had declined, relative to the USD.

Domestic assessment

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

• subdued labour market, where growth in the labour market is slower than population growth, and only modest prospects for labour force growth are apparent
• consumption was observed to be weaker than what had been implied by the relatively strong pick-up in retail sales during the March quarter, while business investment was seen to have declined, along with dwelling investment being “flat”
• business sentiment and conditions were still diverse, being stronger in the non-mining sector, and weaker in mining and manufacturing
• wages cost growth was generally seen as being well contained, although little new data was available

Importantly, the RBA noted growth was below trend, as the RBA note below

The national accounts for the March quarter were released the day after the June Board meeting and confirmed the Bank's expectation that GDP had continued to grow at a pace a bit below trend in recent quarters. Members noted that consumption was weaker than had been implied by the relatively strong pick-up in retail sales in the March quarter, while business investment declined and dwelling investment was flat. Exports increased further in the quarter, particularly resources, while imports fell sharply in line with the decline in mining investment.

Considerations for monetary policy

In the context of lower than expected domestic inflation, with sub-trend growth, the RBA still maintains that there is further scope to ease monetary policy further, although it did more fully acknowledge the impact of a lower Australian dollar on inflation. 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

Given the exchange rate adjustment that was occurring, and with the substantial degree of monetary stimulus already in place, members assessed the current stance of policy to be appropriate for the time being. The Board also judged that the inflation outlook, although slightly higher because of the exchange rate depreciation, could still provide some scope for further easing, should that be required to support demand ([emphasis added]).

Conclusion

Markets have become more aggressive, in terms of pricing in an easing before the release of these minutes, given recent employment data. While the minutes reduces the dovish tone of the prior RBA releases, the reason bond markets rose slightly in yield is mainly to do with the weaker than expected release of employment data, last week.

However, it remains apparent that 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.

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. Also, the announcement of the emissions trading scheme (ETS) yesterday will lead to a marginal fiscal drag, and a marginal reduction in electricity pricing, over the medium term. In other words, the ETS is a marginal positive for another easing, all else being equal.

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.