The RBA Explains Itself

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This story features BENDIGO & ADELAIDE BANK LIMITED.
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The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

The Reserve Bank of Australia under governor Glenn Stevens has decided it’s high time the bank stepped up its disclosure. Prior to today, if the RBA were to leave rates unchanged one could only guess as to why – there was never an accompanying statement. If it changed rates an explanation was given, but otherwise the market had to wait for monthly statements for some clues as to what the RBA was thinking. This was in contrast to the US Fed, for example, which inundates the market with accompanying statements and minutes of its meetings.

But today, for the first time, the RBA has released a brief summary as to why it left the cash rate unchanged along with the full minutes of the meeting. It will continue to do so from now on. Further, the bank has decided this business of meeting on the Tuesday but waiting to release its decision on the following Wednesday is a bit of a charade as well. As of February, the RBA rate decision will be released to the market at 2.30pm on the day of the meeting.

So, what’s the drum?

The RBA is still concerned about domestic inflation, and has reiterated its belief that inflation will surpass 3% in the first half of 2008 before falling away thereafter. It also reiterated its mantra that Australian demand and output are strong and that there is little in the way of surplus capacity. All this points to a need to raise rates further.

However, despite the fact Australia is less affected by the current turmoil in world credit markets, and “the flow of credit to sound borrowers does not appear to have been impaired”, Australia cannot escape the fact that global costs have risen appreciably and the effect has been passed on. The cost for business borrowers has increased both through local monetary policy changes (two rate increases since August) and through market-driven increases in costs for intermediaries.

Note that while the big banks are yet to buckle, and are currently involved in a staring competition, new regional conglomerate Adelaide Bendigo Bank ((BEN)) this week decided to put its borrowing rates up by 25 basis points even before it knew what the RBA might do. This follows similar increases from smaller lenders over the past months.

The RBA acknowledges that more independent rate rises may well occur, and this will help to contain private demand going forward. This in turn should dampen inflation, so on that basis the bank decided December did not need a rate hike. Economists weren’t expecting one anyway.

Nor were the majority of economists in Canada expecting its central bank to cut rates – by 25 basis points to 4.25% – last night. Like Australia, Canada is a resource-rich country with a strong economy, low unemployment and overstretched capacity, and whose currency has appreciated markedly. However unlike Australia, Canada is the immediate neighbour of the US and as such its most significant trading partner. Exports represent 30% of the Canadian GDP and most of those simply cross the border. At the same time, the Canadian population is concentrated near the US border and so it’s not much trouble to cross over to do some shopping armed with valuable Canadian dollars to exchange.

Canada’s September quarter GDP growth came in at 2.9%, but given the more direct impact being felt by Canada from the US subprime-related slowdown expectations are for that figure to halve in the December quarter. In the meantime, the currency effect is serving to reduce inflation as exports suffer from competition and imports are not as highly sought after at home (unlike the isolated island of Australia). Canada’s inflation has slipped below 2%. Hence the decision to cut.

Australia’s September quarter GDP growth was released this morning and at 1.0% met consensus expectations. Year-on-year growth, however, measured 4.3% compared to a consensus of 4.8% due to a downward revision from September. The recently revised US September quarter figure was 4.9%, so with the US at 4.9%, Canada at 2.9% and Australia at 1% one might wonder why Australia is relieved the central bank didn’t raise rates this morning when Canada has cut and the US will follow next week.

The answer to that is really the $64 dollar question. Will Australia be dragged down by a slowdown in the US economy? The RBA cites a “heightened uncertainty about the international outlook” as the reason not to raise rates today. But the general consensus among economists is that Australia’s economic fortunes are tied to Asia, not to the US, and there are no expectations Asian economic growth will collapse due to a US slowdown. Asian domestic economies are growing rapidly.

Nevertheless, Australian corporate profits fell by 2% in the third quarter when they were expected to rise by 2%. Export supply constraints, increased costs and the effect of the strong Aussie were blamed. The same factors were blamed for the deficit blow-out in Australia’s balance of trade. Meanwhile, two interest rate rises since August have impacted on the retail sales numbers, indicating there is some moderation in Australian domestic demand. With rates set to rise further independently, this moderation may yet continue.

The RBA actually did downgrade its global economic growth expectation in its statement – from “above trend” to “trend”.

So should Australia now expect that earlier warnings of more rate hikes to come in 2008 can also be moderated? Not so say most, but not all, economists.

TD securities points to forward estimates on wage and employment gains as well as a promised $105bn in income tax cuts to come. The economists still expect inflation to cross the 3% mark as the RBA has speculated.

ANZ suggests today’s GDP numbers vindicate the RBA’s two previous rate hikes, coming despite a global financial “meltdown”. The annual GDP growth rate of 4.3% is at a three-year high and well above its 3.00-3.25% “medium term potential”. Nor does the ANZ believe the two hikes will sufficiently dampen aggregate demand, and thus inflation, to stave off a further rate hike next year. While the December quarter CPI figure and ongoing developments in global financial markets will be influential, ANZ doubts whether these will make an ultimate difference.

Macquarie economists are among the most hawkish on interest rates, expecting anything up to three hikes early next year. But then Macquarie also expected a quarterly growth increase of 1.2% today for a subsequent annual rate of 5%. Westpac points out that non-farm GDP actually fell more than expected within the total figure. Non-farm quarterly figures for the year have been 1.3% last December, 1.6% in March, 1.0% in June and 0.6% in September. Is this an economy that should be hiking rates?

Westpac is still leaning toward that belief, given its belief the domestic economy still has a lot of strength factors behind it. But stabilisation of global credit markets is a necessary factor as well.

St George, on the other hand, made its opinion known recently that it believes the US will affect a global economic slowdown that will impact on Australia. The economists are suggesting no change to rates for six months.

And as we speak, global base metals prices are looking precariously weak. Just how bullish are the near term prospects for the Australian economy really?

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