Australia | Apr 21 2009
By Greg Peel
Back in March, the Reserve Bank of Australia decided to keep its cash rate unchanged after a series of aggressive cuts, deeming monetary policy to now be ahead of the curve rather than behind it. This was despite the fact the minutes of the meeting revealed “Members noted the rapid deterioration in the world economy in the December quarter and the likelihood that many countries would experience further sizeable falls in output in the current quarter,” and furthermore, “Although there had been an improvement in conditions in global credit markets over recent months, a lack of clarity about how overseas authorities would resolve problems in their financial sectors had significantly weakened equity markets, particularly for financial stocks”.
Very soon after the meeting global stocks turned and began to rally, led by financial stocks in the US. To that end, the RBA noted in the minutes of its April meeting (released today): “Conditions and sentiment in global financial markets had continued to improve gradually over the past month. The improvement, which had included a sizeable rally in equity markets, had been helped by the announcements of more detailed plans for a resolution of banking system difficulties in the United States and other major countries.”
The board nevertheless acknowledged this was simply a first small step along a long road, and moreover, “It was clear from the information that had become available over the past month that the very sharp contraction in the global economy in the final quarter of 2008 had continued during the first few months of this year”. The board also acknowledged recent World Bank, IMF and OECD reports which suggest global economic growth has turned negative for the first time in 60 years.
In short, the RBA continues to believe Australia’s position is much better than most but the largest economies of the world continue to see deteriorating conditions. The March quarter appeared to be another weak one for Australia however, with credit growth slowing (ex of first homeowner grant-inspired mortgages).
The March meeting was all about whether having cut a long way, it was time for the RBA to pause and reflect, and wait to see what news fresh data was to bring. To that end:
“The question for policy was whether further stimulus should be added at this meeting, or whether, having reduced rates at each meeting since September, the Board should pause for a further evaluation of the situation. Members could see reasonable cases for both courses of action. On balance, they judged that, having made a major change to monetary policy over the preceding several meetings in anticipation of weak economic conditions, the best course for this meeting was to leave the cash rate unchanged. Members believed this would leave adequate flexibility for policy at future meetings.”
It was “flexibility” which tipped economists off to a likely rate cut in April on the basis of ever weakening economic data, although not everyone was convinced. Half the market believed the RBA would still let things ride for a while. Hence we had a camp split between those expecting no rate cut and those expecting 50 basis points, with a handful (FNArena included) tipping 25.
I’m prepared to bet the RBA took this split of sentiment into consideration (it is noted in the minutes) before settling on 25 basis points as the compromise. Economic data were certainly weak but the crucial final element was inflation. The RBA has been harbouring a lingering inflation fear for some time based on Australia’s growing terms of trade (heavily influenced by annual contract prices for iron ore and coal) which has offset deflation considerations. The RBA acknowledged in April that fresh annual contract prices would be lower, but still strong by earlier comparisons. But the board also noted that “a period of low capacity utilisation” and “a weaker labour market” were encouraging the decline in inflation over the medium term. In the end, inflation was a deciding factor:
“Given this background, the question for the Board was whether there was a case for additional monetary easing. In discussing this question, members noted that there had already been a major easing in both monetary and fiscal policy in Australia in the past six months. Interest rates on loans to households and many businesses were now at low levels by historical standards. The interest rate reductions had lowered debt servicing burdens considerably, particularly for households. This stimulus, together with the substantial fiscal measures, would support demand and help to foster economic recovery in due course. Nonetheless, the effect of recent international and domestic information had been that the near-term outlook for demand and output in Australia was now weaker than earlier expected, though a recovery in demand was likely towards the end of the year. A period of low capacity utilisation and a weaker labour market was seen as increasing the likelihood of a decline in inflation over the medium term. As such, members saw scope for a modest reduction in the cash rate.”
And so we got a 25 point cut.
Will we get another cut in May? Well firstly, the RBA has quietly brought us back to the 25 basis point increment, which is more appropriate on a 3.00% cash rate than 100 points. Secondly, while the stock market has continued to rally (not today) economic data have shown no signs of improvement, particularly forward-looking indicators. And finally, yesterday’s PPI showed a marked decline when a small increase was expected.
We will await with interest tomorrow’s CPI result, but it appears inflation is indeed now declining quickly. This allows the RBA further room to move on rates, and it will probably do so.
The only offset is how the banks will respond. There is not a lot of point in the RBA lowering rates to stimulate credit growth when the banks refuse to pass on all of the cut (or any of it, in NAB’s case) citing increasing funding costs. Suddenly we have a rush of increases to fixed mortgage rates. Would another cut make any difference?
Maybe it’s a case of you need two cuts from the RBA to get one decent one out of the banks. Or will the RBA be forced to join other central banks across the globe and adopt “unconventional measures”, such as intervention in corporate lending markets? Economists still generally believe Australia’s cash rate will bottom out between 2% and 2.5%, and we’re not there yet.