RBA rate decision - Easing on the agenda

As expected, the RBA statement yesterday indicated that the cash rate was to be left unchanged at 3.00%. While expectations of an imminent rate cut by some market participants were not realised, we would expect cash rates to fall over 2013, given the need to support the transition from mining led growth to construction sector led growth. By the end of 2013, we expect the cash rate to be 2.50%.

Business leaders on the RBA board are focussing attention on the high Australian dollar and the depressing impact on the export sector. Meanwhile, the consumer refuses to reduce saving and increase debt. In addition, 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.

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, and further easing is on the way.

Statement

The following points are evident from the statement:

• Global growth: Global growth comments were revised upwards from the prior statement on 5 December 2012, although possibly not as much as the market had expected. Also, the RBA acknowledged that commodity prices have now firmed. Regional growth was noted to have “slowed” with increased uncertainty about the outlook. As the RBA indicates,

Global growth is forecast to be a little below average for a time, but the downside risks appear to have abated, for the moment at least. The United States has so far avoided a severe fiscal contraction and financial strains in Europe have lessened considerably over recent months. Growth in China has stabilised at a fairly robust pace. Around Asia generally, growth was dampened by the earlier slowing in China and the weakness in Europe, but again there are signs recently of stabilisation. Some commodity prices have firmed over recent months.

• Financial market developments: In general, the assessment of financial market developments was largely unchanged from the prior statement, where a growing recovery in sentiment was apparent. However, risks remain as, “the task of putting private and public finances on sustainable paths in several major countries is far from complete and, accordingly, financial markets remain vulnerable to setbacks in these areas.”
• Domestic economic developments: In general, the RBA summarised domestic conditions by noting that growth “has been running close to trend”, as it did in December. Importantly, the two new aspects that were evident in the December statement were repeated in yesterday’s statement. First, dwelling investment was observed to be “subdued”. Second, the assessment of labour market conditions continued to acknowledge that the labour market is “softening somewhat and unemployment is edging higher”.
• Inflation: The RBA repeated most of what it said last month, yet the softening in the labour market was seen to help contain the inflationary impact of the carbon price. However, the RBA continue to emphasise that even further improvements in productivity are needed, so as to offset the “waning” impact of the higher currency on inflation.
• AUD: Once again, the RBA noted that “the exchange rate remains higher than might have been expected, given the observed decline in export prices.
• Prior easing: The RBA stated that the easing over 2012 was “significant” and needed to filter through, though some impacts of the easing were already apparent. Yet, the RBA noted the failure of lower rates to stimulate credit growth, noting “the demand for credit is low” and adding from the last statement “as some households and firms continue to seek lower debt levels”.
• Final paragraph: Here, the RBA noted that while the prior easing in 2012 was substantial, and that the current “accommodative” stance was appropriate, the current inflation outlook does afford scope to ease further, as the RBA noted,

The Board's view is that with inflation likely to be consistent with the target, and with growth likely to be a little below trend over the coming year, an accommodative stance of monetary policy is appropriate. The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand. At today's meeting, taking into account the flow of recent information and noting that there had been a substantial easing of policy as a result of previous decisions, the Board judged that it was prudent to leave the cash rate unchanged. The Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the target over time.

Other factors

Markets are now correcting somewhat exuberant expectations, which were supported by the delay, not solution of, fiscal negotiations in the US. However, rising mortgage rates and rising fuel prices are moderating US growth, and when combined with continued wrangles in the US over fiscal issues, indicate that growth expectations need to become somewhat more realistic. Popular revolt against austerity in Europe is growing, and is beginning to concern financial markets, which have now become overly complacent on European problems. A target of 1.50% on the US 10 year Treasury bonds is more than 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 3.50%.

Conclusion

While financial market commentators are “jumping at shadows”, the fact remains that inflation remains well in control and that such control affords scope for the RBA board to assist in the transition from mining related growth to non-mining related growth. A structurally more conservative consumer is preventing the typical transmission of lower rates to activity at this point, and this is what is making the prospect of further easing tantalisingly close.

Further, elaboration of the domestic and global economy will be given in the forthcoming Statement of Monetary Policy, due on 8 February. While many had rightly judged that the improvement in the global economy would allow the RBA some time to assess prior easing, the domestic economy still remains disappointing with the unemployment rate now set to rise, and with the construction sector still showing unimpressive growth; certainly not enough to offset the fading impact of the mining boom. Further RBA easing will be needed to encourage borrowing, and thus non-mining growth, from a now timid consumer.