Australia | Mar 26 2009
By Andrew Nelson
Until yesterday, Westpac was one of the many that were expecting the RBA Board would again reduce the overnight cash rate on April 7. The bank’s call was for a cut from 3.25% to 3%, but things have changed and Westpac’s global head of economics, Bill Evans, now thinks the central bank will decide to keep rates on hold at the next meeting.
Westpac does, however, remain of the opinion that the low point in the cash rate for this cycle will be 2%. The only difference now is that it believes the RBA will take a little longer to reach that target.
Evans admits he has argued in the past that the most efficient policy approach should be to reduce interest rates as quickly as possible, as this would ensure maximum stimulus for the economy. However, the board’s decision in March to pause despite some disturbing data on the Asian economies and a further deterioration in the Australian outlook, indicates that central bank has decided to take a different approach to these last stages of the easing cycle.
The RBA is in a much different position than the US Federal Reserve. Despite an effective zero Federal funds rate, Evans points out the Fed is still able to buy Treasuries in order to lower the cost of fixed rate mortgages. On the other hand, the RBA only has one policy trick up its sleeve and that is to fiddle with the overnight cash rate in an attempt to move the prime variable mortgage rate.
Given it only has one option, Evans thinks the RBA has probably chosen to conserve some ammo lest it be left in a position of not having any means at hand to respond to unexpected negative events over the course of 2009, or later. Evans thinks it is more than reasonable for the RBA to assume that a rate cut in response to negative domestic or overseas developments will be able to at least provide some boost to confidence, as it shows the bank is still in the game.
With only 125 bps up its sleeve at the most, given it has aggressively cut by 400 bp’s in just over 5 consecutive meetings, the board would probably fear it only has a few shots left. As such, Evans feels the RBA will probably want to hang on to that flexibility until things start looking ugly again. Given a few weeks of clear sailing, it looks like now isn’t that time. Confidence in global financial markets has soared over the last few weeks, with equity markets in particular showing near record increases.
But it wont be that long until things turn sour again, says Evans, with plenty of ugly news probably still in store for 2009 and into 2010. As such, he doesn’t expect current levels of investor confidence will be sustained, particularly as he expects the flow of dismal economic data to continue apace for both Australia and the world. For now, however, the Bank will likely take a little heart from the recovery in the latest Australian lending for housing figures, although it is too narrowly based to pin any medium, let alone long-term hopes on. This is especially so given much of the upside is due to federal stimulus that will eventually level out.
Still, a pause to get a good grip on how the government’s second stimulus package that is currently being implemented is affecting the economy makes pretty good sense, thinks Evans. Given this view, he does not rule out the possibility of a continuation of the pause in May. However, an eventual 2% floor will almost certainly be established, but probably not until the fourth quarter.