Australia | Dec 21 2010
By Greg Peel
In November, the board of the RBA had been waiting for several months to see whether the debt situation in Europe would deteriorate further. On the flipside, Chinese GDP growth in defiance of fears of a hard landing had been putting more and more upward pressure on Australia's terms of trade and the unemployment rate had continued to fall. The situation was “finely balanced”.
While the board decided that a “case could be made for waiting a little longer”, it also noted that “compared with several months ago, downside risks to the global economy had still not materialised in any way”. And thus the RBA surprised the market and raised its cash rate by 0.25% to 4.75%. The banks followed with near double mortgage rate increases, but the RBA had expected them to do so.
If the situation was indeed so finely balanced, the board members must have been clutching their brows in despair when Ireland blew up about five minutes later.
This brought us to the December meeting, at which the RBA left its rate unchanged. The accompanying statement suggested the outlook was for inflation to remain controlled for several quarters, and the rate setting was deemed to be appropriate for “the outlook”. In other words, the RBA appeared to be telegraphing that it would not be rushing to change rates again for a while. And there was no talk of “depending on data flow” or being appropriate “for the time being”.
I had hoped that the minutes of that meeting, which were released today, would provide more colour and more concrete hints that the RBA is on hold for at least six months. While I still believe it will be, the minutes were comparatively brief. The “Considerations For Monetary Policy” conclusion was one of the shortest this year.
But it was nevertheless succinct. “Members noted that the deterioration in Europe over the past month had increased the downside risks to the global economy. How this would ultimately play out, and the implications for Australia, were difficult to predict”. So having believed that the uncertainty over Europe had settled down in November, now the RBA was back wondering what might happen next, without any real way of knowing.
Most importantly, the board suggested that if Europe's troubles “prompted a fresh retreat from risk-taking in global financial markets, it would probably have more impact on Australia than any trade effect”. (My emphasis)
On the assumption that European concerns do not suddenly dissipate in the next couple of months – and given there is a resistance in the EU to increase the current emergency fund while Spain teeters it is unlikely that fear will abate quickly – then it is also unlikely the RBA will be inclined to shift policy from what it now suggests is “mildly restrictive”. All year the RBA has been most concerned about Australia's commodity boom, courtesy of China and India, and the impact that could very suddenly have on inflation. The December minutes, however, suggest that a real blow-up in Europe renders that boom (ie “any trade effect”) irrelevant.
Given the RBA kept its cash rate stuck on 4.50% from May through to November while exports of coal and iron ore boomed showed just how concerned the board was over Europe, and to a lesser extent a possible Chinese slowdown. While it appears the central bank is no longer fearing a Chinese slowdown, it is clearly fearing what might yet transpire in Europe and the global ramifications. The bank's policy stance of most of 2010 thus may very well be mimicked in 2011.
Another factor which had not been touched on in November or previously, with regards to Australia's domestic economy, is Australia's surprisingly strong savings rate. The increase in savings had not been as noticeable as it was in the most recent data, and clearly the retail and other sectors have been suffering as a result.
It is that worth noting the RBA's comments in these minutes that “the saving rate had increased noticeably over the past few years”. More importantly, the board's conclusion from the data was that “This restraint, if it continued, would provide some scope for investment to rise without causing aggregate demand to grow too quickly and inflationary pressures to build”.
In other words, even taking Europe out of the equation, perhaps the RBA was a bit hasty in naturally assuming the expected growth in investment, driven by resources, must ultimately translate into high inflation. Put these two factors together – the international and the domestic – and it's very easy to make a case that rates do not need to rise for some time yet.
Indeed, I still believe the RBA, with the benefit of hindsight of course, now wishes it never raised the cash rate in November.
Read the full December minutes here.