RBA rate decision – easing bias largely unchanged

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 still expect cash rates to be reduced 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 continuing negative impact on the export sector, which has been created by the higher currency. Meanwhile, the consumer generally 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 largely unchanged from the prior statement on 5 March 2013. As the RBA indicates,

Global growth is forecast to be a little below average for a time, but the downside risks appear to be reduced. While Europe remains in recession, the United States is experiencing a moderate expansion and 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 of stabilisation. Commodity prices have declined somewhat recently, but are still at historically high levels.

• Financial market developments: In general, the assessment of financial market developments was largely unchanged from the prior statement, where a growing recovery in sentiment became apparent. However, instead of the financial markets being vulnerable to “occasional” setbacks, the RBA eliminated the reference to setbacks being “occasional”. Domestic economic developments. In general, the RBA noted that “the substantial easing of monetary policy during late 2011 and 2012 is having an expansionary effect on the economy”. Further impacts of accommodative policy were anticipated, yet those impacts are needed as “there will be more scope for some other areas of demand to strengthen”. Generally, the outlook for non-residential construction was seen as being “relatively subdued”, while dwelling investment appears to be “slowly increasing”, with “rising dwelling prices” being apparent.
• Inflation: As labour costs remained “contained” and the focus of business remains on lifting efficiency, the inflation rate was observed to remain low, as the RBA indicated,

Inflation is consistent with the medium-term target, with both headline CPI and underlying measures at around 2¼ per cent on the latest reading.

• Final paragraph: Here, the RBA noted that while the prior easing in 2012 was substantial, and that while the current “accommodative” stance was appropriate, the current inflation outlook continues to 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, 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

Recent releases from Europe have been surprising economists in terms of how weak these releases have become, and this may well have something to do with recent developments in Cyprus. These recent developments are shown quite clearly in the recent readings from the Citigroup economic surprise index, as shown below, which has plummeted of late, as releases have come in lower than expected. This index measures the degree to which economic releases exceed, or fall short of, consensus forecasts, and a lower reading tends to indicate that expectations have become somewhat elevated, where releases fall short of expectations, as Figure 1 shows below,

Figure 1

Further weakness in European economic releases, as implied by Figure 1, especially if the recent trend of weaker than expected releases continues, may be one of the factors that pushes the RBA to act and ease further in the context of a weaker than expected global economy, towards the middle to latter part of the calendar year.

Conclusion

Markets are continuing to correct from somewhat exuberant expectations, where the fiscal drag from sequester related cuts to government spending begins to slowly, but surely, weigh on economic growth. Meanwhile, the Cyprus situation remains of concern to European banking, as the ongoing credit squeeze in Europe gradually leads European growth lower, and lower. Also, popular revolt against austerity in Europe is growing, as the recent Italian government impasse tends to emphasise. In Australia, a structurally more conservative consumer is slowing 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 RBA easing will be needed to encourage borrowing, and thus non-mining growth, from a now extremely conservative consumer.