Australia | Aug 19 2008
By Greg Peel
In the minutes of the July Reserve Bank board meeting, it was noted that the increasing signs Australian demand was slowing “suggested that the existing policy setting was exerting the appropriate degree of restraint”. Hence monetary policy also remained “appropriate” and the cash rate stayed at 7.25%.
The cash rate also remained at 7.25% in August, but this time the RBA minutes, released today, noted “less restrictive conditions could soon be called for, otherwise the risk of a deeper and more persistent slowing in the economy would increase. On these considerations, a case could be made for an early reduction in the cash rate”.
These words were a step up from those appearing in the recent quarterly statement, which suggested “a move towards a less restrictive setting of monetary policy was judged to be increasing”. Nevertheless, those same words also ended this month’s minutes.
So the possibility of a rate cut is still deemed only to be “increasing”. This is a rather vague statement, and does not really imply emphatically that a rate cut must be forthcoming as soon as next month. But now we also learn that a rate cut might be necessary “soon”, and that there is a case for an “early” reduction.
So how long is “soon” and on what scale is “early” being measured? Is next month too soon to be “soon”? And “early” before what? Early as in before the release of the September quarter economic data, including GDP and CPI, or early as in before inflation levels actually begin to trend lower?
Clearly the central bank is not going to say “we decided not to cut rates this month but we will next month” because, as we’ve seen all year, much can change in a month. And if the board had decided to cut anyway, why wait? So we can still only believe that perhaps the “soon” and “early” clues may mean September, assuming economic data continue to weaken in the face of a CPI, which is already expected to be high anyway.
Maybe there will be a cut in September, of 25 points, just to ease off a tad. It appears the RBA is quite surprised at just how fast the Australian economy has slowed. The evidence abounds in the section of the minutes relating to the domestic economy.
Consumption spending had “weakened considerably in 2008”, the board noted. The expansion of housing stock was “noticeably below long term growth”. Household net worth had “declined by almost 5% over the first half”. The measure of business confidence had “fallen well below average”. Growth in business borrowing had “slowed sharply”. And, again, there were some “early signs of easing in labour market conditions”.
By comparison, the July minutes used less of the “noticeably” and “sharply” and more of the “flat” and “soft”.
If this isn’t enough to scream rate cut alone, the international appraisal received a similar change of assessment. Last month the economic evaluation of Australia’s major trading partners “had not changed in recent months”. While the picture in the US was still “uncertain”, both Japan and Europe were seen as “stronger than expected” and Asia as “strong thus far”.
This month, however, international conditions were “generally seen as weak”. Japan was “deteriorating”, Europe “slowing” and growth had “slowed a little” in China. On the international assessment basis, coupled with the domestic assessment, you’d have to say a September rate cut was a lay-down misere, in the bag, home and hosed, and a sure thing. Particularly when you throw in “credit concerns have resurfaced in global markets”, financial conditions had “generally deteriorated”, and a special nod to Fannie and Freddie.
Yet…
A funny thing happened in August’s set of minutes. As per usual, the headings of specific areas of discussion were ordered as International Economic Conditions, Domestic Economic Conditions, Financial Markets, and Considerations for Monetary Policy. But this time there was a new heading, and it came before all others. It was entitled Inflation.
In this new, stand-alone segment, it was noted that commodity price inflation had indeed increased, but we all knew that anyway, but also that the cost of services had “increased strongly over the past year” and that there was still “stronger inflation pressure in Australia than in other developed countries”. That said, and thrust to the front of the document, further inflation discussion was reserved for the Considerations for Monetary Policy section.
Here, yet again, the RBA made note of the “powerful forces pulling in opposite directions”, being a slowing economy on the one hand and the rising terms of trade – which would “continue to add substantially to national income and capacity to spend” – on the other. There may have been a recent easing in commodity prices, but the board made note that coal and iron ore prices were still 30-40% above the most recent established contract prices.
So faced with these two “powerful” forces, the board members based their decision on two “key considerations”. Firstly, that a “lengthy” period of inflation above the target was occurring, which threatened to push up wages. This hadn’t happened yet, but there was still a risk. And the “cost of reducing inflation later would be greater”. On this basis, interest rates should not be lowered.
But secondly, financial conditions were “clearly quite tight”, and if the RBA did not move to “less restrictive” policy soon the risk increases of a “deeper and more persistent slowing in the economy”.
And the latter is why the case could be made for an “early reduction in the cash rate”.
These minutes are a lot more emphatic than the quarterly monetary statement was, even though they were written beforehand (or does Stevens write the statement a lot earlier before it spends a month at the printer’s?) Emphatic in the sense that a cut might be needed “soon”.
If there is further economic weakening in the data released between now and the September meeting (there’s not much data actually, but perhaps enough) then it looks like a 25 basis point cut might indeed be forthcoming in September. It will thus be “early” in the sense of ahead of the quarterly data, which won’t see the light of day until after the October meeting, rather than “early” in the sense of before inflation eases, which the RBA does not realistically expect to start happening until at least next year.
However, calls of a 50 point cut are misguided, and calls of two consecutive cuts are probably off the mark as well. If the RBA cuts in September, it will watch what happens before it considers moving again.