Australia | May 01 2012
By Greg Peel
Well I stand corrected, given I was in the “only 25” school. My thinking was that a one-hit 50 basis point cut in the RBA cash rate would tend to suggest an “emergency” situation and risked the RBA board looking foolish for not having delivered incremental cuts earlier. Perhaps I should have recognised the first 100bps cut in 2008 to be the stuff of “emergencies”, and that the RBA is being forced to counter a new rate-setting policy from the banks.
Whatever the case, today the Reserve Bank cut its cash rate to 3.75% from 4.25%, likely killing off any suggestions of a June cut, but not for the reasons expected.
The first point one notices from the RBA statement is that the central bank's macro assessment remains little changed from April when no cut was delivered. World economic growth is below trend but not looking at a deep downturn, US economic growth is moderate, China's growth is moderating as intended, and Europe “will remain a potential source of adverse shocks for some time yet”. Today's cut was thus not simply macro, or global market-related, or the board would have declared a heightened fear. Today's cut was a domestic response, with global interest rate differentials and a strong currency as a result providing plenty of scope.
Last month the RBA suggested Australian bank funding costs had declined but were higher than a year ago – a point seemingly lost or selectively quoted by bank bashers and politicians. This month that observation was reiterated. However, this month Governor Stevens did add that market sentiment remains “skittish” over what might transpire in Europe, which hints of a concern that bank borrowing costs could shoot up again.
Last month the RBA all but guaranteed at least a 25bps cut this month with the one caveat of waiting to check the March quarter inflation data. That turned out to be even lower than expected, opening the big policy door. Stevens notes headline inflation has declined from 3.5% to 1.5% as food price shocks have reversed as expected, and carbon price notwithstanding, he expects inflation to hang around at the low end of the 2-3% range over the next one to two years.
Perhaps one of the most important observations the RBA makes in this month's statement is as follows:
“As a result of changes to monetary policy late last year, interest rates for borrowers have been close to their medium-term averages over recent months, albeit tending to increase a little as lenders passed on the higher costs of funding their books. Credit growth remains modest overall.”
Here we have a nod to the gradual change of policy from Australia's big banks. For reasons no one can quite remember, the RBA cash rate has always been the fundamental element in setting mortgage SVRs and other bank lending rates. Yet the RBA cash rate is an overnight rate, and your average mortgage has a duration of 20 years. On that basis banks borrow offshore at around the 4-5 year duration mark, and that cost really should be the most influential element in retail rate setting.
ANZ Bank ((ANZ)) has been the first to publicly break from tradition, announcing it will from now on set its lending rates once a month without singular reference to the RBA cash rate. The other banks are yet to publicly endorse this move, but they are heading in that direction too. Out-of-cycle rate increases and diminished cut pass-ons in recent times are the clues. The RBA is obviously fully cognisant of this development, and while itself supporting commercial bank policy the result is a requisite change in central bank policy. The RBA can no longer simply assume a cash rate cut will be rapidly passed into the economy through equivalent bank rate cuts. This sort of works both ways, given it appears to have forced this full 50 points today but may one day suggest no change when change is expected.
In April the RBA noted its belief that since the last rate cut in December, the level of policy setting had appeared appropriate for the time being but that low inflation meant plenty of room to move if needed. Today the statement notes “The accretion of evidence suggests that it is now appropriate for a further step in that direction”.
At the end of the day, it's a conflagration of Australia's “two-speed economy”, an easing in mining boom expectations, lingering doubts over Europe and a change in policy from the banks. It all adds up to “scope” for a 50bps cut in one hit. As is noted:
“In considering the appropriate size of adjustment to the cash rate at today's meeting, the Board judged it desirable that financial conditions now be easier than those which had prevailed in December. A reduction of 50 basis points in the cash rate was, in this instance, therefore judged to be necessary in order to deliver the appropriate level of borrowing rates.”
Unless a shock occurs in the interim, I think we can put talk of a June rate cut aside.
Read the full statement here.
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