Australia | Nov 18 2008
By Andrew Nelson
The Reserve Bank’s November Board minutes indicate the board’s main concern was keeping Australia in front of the continuing deterioration in the outlook for the world economy. But with more downgrades to international and domestic growth forecasts likely to come, the RBA wants to hit a “neutral” policy stance as quickly as possible to soften the fall.
However, the decision to cut the cash rate by 75bps to 5.25% was made at the twelfth hour, as the paper prepared for the board the week earlier had suggested a cut of 50bps. On the day of the meeting, however, RBA Governor Glen Stevens asked the Board to consider either 50bp or 75bp due to the further release of weak economic data in the interim.
The RBA notes that both falls in the stock market and in house prices over the preceding months had produced a downward trend in household wealth that had “few precedents”. All up, the RBA’s forecasts for output growth implied a period of overall growth well below trend, even with the boosts from lower interest rates and the Federal Government’s fiscal stimulus package. It also made it more likely that inflation would fall over the coming year, freeing the bank up to focus on economic stability.
In the words of the RBA, it saw “given the changing balance of risks, an advantage in moving the setting of monetary policy quickly to a neutral position”. The minutes also indicate the board was most definitely looking to have an impact on rates paid by borrowers and thought a larger than expected cut could help boost confidence among consumers and businesses.
This is clear evidence the board thought rates needed to come down and given the pace of deterioration in the economic outlook, it appears the board took a sooner rather than later approach to the size of cuts.
Some would argue the current rate of 5.25% is neutral, at least it was neutral in the last few cycles, but Westpac Chief Economist Bill Evans thinks the rules are a little different this time around and that 4.5% is the new neutral. Why? Because the banks have been unable or unwilling – or likely a little bit of both – to pass through rate cuts in full to borrowers.
The limited pass-through has blunted the RBA’s ability to make finer adjustments to the economy and is a direct consequence of the credit crisis. Evans thinks this is likely to remain an obstacle to the RBA’s attempts to stimulate demand and breathe a bit more life back into the Australian economy.
So when the board was left with a decision to cut rates by either 0.50% or by 0.75%, ABS stats from the day before showed a 1.1% fall in retail sales in September and a 1.8% drop in the house price index for the September quarter, which was the sharpest fall for some time. Add the fact that financial markets were still every bit as jittery as they had been in the preceding month when 1% was lopped of the official cash rate, and the stage was set for the bigger of the two choices.
The size of the cut served its purpose, surprising the market for a second month in a row, saying its “members were conscious of the high rate of inflation at present and of the need to bring it down over time, but felt that in the current environment a reduction of this size would not undermine that task.” The ongoing downward revisions to the international and domestic growth outlooks have eclipsed the RBA’s earlier concerns about elevated inflation.
That’s not to say inflation isn’t still a big blip on the radar screen, but the minutes indicate that it is of decreasing concern and that the issue will work itself out. The bank said that if if current petrol prices were sustained, there would be a noticeable fall in headline inflation in the December quarter and this would assist in containing inflation expectations. Commonwealth Bank Senior Economist Michael Workman notes that while lower petrol prices could take about 0.5 percentage points off the December quarter headline CPI figures, the underlying numbers are unlikely to benefit from a big fall in petrol.
But the mood on inflation was tempered with the view that a further depreciation in the exchange rate “meant that the decline of inflation could take longer than previously thought”. TD Securities Senior Strategist Joshua Williamson notes that with GDP growth likely to slow by more than both the Government and RBA expects, it will be harder for businesses to increase prices due higher input costs from the depreciation in the AUD. He expects businesses will have to absorb the higher costs through lower profit margins instead.
So where does this place us for December? Well, again we’re faced with the question of another 50 or 75bp given neutral on most peoples’ cards is around 4.5% and there won’t be an RBA board meeting in January. ANZ economist Riki Polygenis expects the RBA to cut the cash rate by 50bp at the December meeting, but admits with the RBA clearly paying very close attention to day to day developments, a larger 75bp move is possible.
TD Securities sees a 75bp December cut as the “right amount of monetary policy medicine” given Q308 GDP growth is likely to be flat and Japan, Australia’s top export destination by value, is now technically in recession. Williamson expects little help from China as well. He picks 4% as the bottom of the cycle, but admits there’s still plenty of downside risk to that estimate.
Westpac thinks rates will be cut by a minimum of 75bp and thinks there is the possibility that we could see another 100bp on December 2 in order to force the rate to a neutral stance.
Commonwealth Bank Senior Economist Michael Workman expects another 100bps of RBA rate cuts by Q109, but only 0.5% in December. He says that financial markets have priced in a reasonably aggressive RBA easing profile and are expecting to see a cash rate of 3.25% by mid 2009.