Australia | Aug 11 2008
By Greg Peel
The Reserve Bank of Australia left its cash rate unchanged at 7.25% last week, which surprised no one. What did set the cat among the pigeons however, or should we say the doves among the hawks, was the final paragraph of the RBA’s brief accompanying statement. It included this line:
“Weighing up the available domestic and international information, the Board judged that the cash rate should remain unchanged this month. Nonetheless, with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.”
While RBA has not yet released the specific minutes of that meeting, it today released its quarterly statement on monetary policy. Economists have been eager to search the statement for more clues. For that little line above changed the entire Australian monetary policy landscape in one fell swoop, as far as economists are concerned. The more alarmist among them are now calling for not a just 25 basis point cut, but a 50 point cut, and not in October after the September quarter CPI is released, but in September.
The less alarmist are pretty sure it will be 25 in September. I’ve always said no cut till November, and after reading the RBA statement on monetary policy ,I’m sticking to that. Nevertheless, it would be a nice one to get wrong.
Once again the most important paragraph in the statement is the last one, and it is an expansion on the line above (my emphasis whenever there’s an underline):
“While inflation is likely to remain high in the short term, the Board judged at its August meeting that demand was slowing to an extent that could be expected to bring about a significant reduction in inflation over time. On this basis the Board decided that the existing monetary policy setting was appropriate for the time being. On the assumption that the subdued demand conditions are likely to continue, scope to move to a less restrictive monetary policy stance in the period ahead is increasing. The Board will continue to monitor developments and make adjustments as required in order to promote sustainable growth consistent with the medium-term inflation target of 2-3 per cent.”
This statement suggests to me that the RBA is in no rush. Of course, one does have to make a judgement on how long “time” really is. There should be a significant reduction in inflation “over time”. Current monetary policy is appropriate “for the time being”. And scope to lower the cash rate is “increasing” but not not yet upon us. This is not the statement of a central bank about to make a highly unusual 50 basis point cut. The last time such a cut occurred was in April 2001.
The argument for the 50 point cut is driven by a strong belief that the banks won’t follow the RBA and cut mortgage rates. It is indeed very likely they won’t, given no bank has been able to rule out another independent rate rise prior to the RBA sending out these recent dovish hints. The banks will risk very bad PR, but what do they care? Politicians can rant and rave and froth at the mouth all they like for the sake of ignorant voters, but it won’t make one shred of difference. Maybe the banks might squeak out a little trimming of rates to look good, but that would be all. The RBA has pushed its rate up 100 points since November and the banks have added another 50 points because of the blow-out in bank cost of funds. That cost has not yet diminished.
So if the RBA is anticipating no move from the banks, it might need to be proactive, or so the argument goes. In theory, the RBA’s monetary policy decision should be independent, and unaffected by what the banks do, but the 50 extra points of interest rate to the upside cannot be ignored. The RBA has constantly acknowledged these independent increases in recent statements, and one would have to presume the RBA cash rate may have reached higher than 7.25% this year were it not for these increases. In this August statement, the RBA again noted that the banks have suffered increasing funding costs, and that “other developments, including higher risk spreads in corporate bond markets, falling equity prices and tougher lending standards, have added to the tightening in domestic financial conditions”.
But for the RBA to make a “shock and awe” rate cut in September, or any rate cut in September, it would need to be convinced inflation is really under control. By September it will not have a CPI reading, although indicators such as the TD Securities-Melbourne Institute monthly measure can be glanced at for guidance. We know that the oil price has come down a long way, but it is not just the CPI the RBA is watching.
The RBA acknowledges in the statement that Australia’s domestic demand is now experiencing “significant moderation”. However, high commodity prices elsewhere are adding to Australia’s trade, and this is a “significant countervailing influence”. So the CPI might be one thing, but “prospects for growth of the Australian economy and for inflation will continue to depend on the net effects flowing from these opposing forces”, being a slowing economy and rising terms of trade.
Commodity prices have come off across the board – oil, base metals, wheat and wool etc – as the RBA notes, but the bank’s “high commodity price” reference refers to iron ore and coal, the prices of which have only been reset recently at much increased levels – for the year – and the effects of which are only starting to come through.
So the bottom line is, to be brutally frank, that if BHP and Rio make too much money then Australian mortgage holders are just going to have pay for that success. And that could well mean the the cash rate will not suddenly be clipped, as many economists are suggesting.
And indeed, while the RBA acknowledges that economies are slowing just about everywhere, including in China, it also takes a leaf straight out the the US Federal Reserve’s book by suggesting “inflation remains a significant concern“.
The statement also recognises that financial markets across the globe are looking pretty sick, and given slowing world growth, “loan losses are likely to increase, which could further weaken financial institutions, hampering the provision of credit and potentially amplifying the economic slowdown”. Australian bank share prices have been taken to the cleaners recently for this very reason, so does that concern the RBA?
“Notwithstanding increases in provisions by some Australian banks, the local banking system remains in much stronger condition than its international counterparts. Markets did not exhibit much tendency to draw these distinctions, however, and share prices of Australian banks also declined”.
So the RBA reckons the Australian market has simply overreacted and the local banking industry is fine. Do we need a sudden rate cut then?
And as quickly as the RBA acknowledges the independent bank rate increases, the statement brings us back to that terms of trade once more:
“Australia’s terms of trade are estimated to have risen by a further 20 per cent since the start of the year, and by a cumulative 65 per cent over the past five years. The income gains from this source continue to represent a significant stimulus to the economy“.
Indeed, every where there is recognition in the statement that there is a building need to cut rates, the RBA provides a counter. “Significant moderation in spending and activity is now underway,” the RBA notes, “though an offsetting factor in the second half of the year will be the tax cuts which come into effect on July 1”.
The other factor the RBA has long been concerned about, with regards to inflation, is a potential wage-price spiral. But once again, while acknowledging that there are “early signs” of an easing in demand for labour, the RBA notes “general moderation in conditions has been less evident in labour market indicators”.
And while there has been a “sharp slowing in credit expansion to both households and businesses”, it is also “too early yet for these recent trends to have a noticeable restraining effect on Australia’s inflation rate”.
And don’t forget that “producer price data also suggest that upstream price increases have remained firm, reflecting both increases in raw materials prices over the past year and higher output prices across a range if industries”.
You see – it’s all about inflation, inflation, and more inflation.
The flipside, of course, is the slowing in Australia’s economic growth. But again, while the RBA acknowledges a “significant moderation in demand is now occurring”, the best it comes up with thereafter is that “economic growth will be fairly slow in the period ahead.” That is hardly a panicked remark.
That leads up up to the final paragraph again, the one that suggests inflation will fall “over time”, and that current monetary policy is fine for “the time being”, even if the scope for a rate cut is “increasing”.
I’m sorry, but my call is “no change” in September – maybe 25 points in November when we know the CPI.