Australia | Aug 18 2009
By Greg Peel
“In recent months, members had left open the possibility of further reductions in the cash rate should further downside risks to the economy emerge. Given the recent improvement in the global and domestic outlooks, it now appeared unlikely that this would be necessary. In fact, if the economy evolved as anticipated in the forecasts, the Bank would in due course need to adopt a less expansionary policy stance.”
These two lines pretty much sum up the distinct change in the Reserve Bank of Australia’s monetary policy view as expressed in the lengthy minutes of August’s meeting, and reinforce the hint provided in August’s statement accompanying another “on hold” result.
In June, according to the RBA, the global economy was showing “tentative” signs of stabilising. By July it had noted there was “further evidence” of stabilising. In August, there had been “additional evidence of an improvement in the global economy, especially in Asia”. So we’ve now moved from stabilising to improving, and the RBA also noted “Global growth forecasts have been revised upward for the first time in more than a year”.
The RBA then goes on to list various improving indicators across the globe.
For the Australian economy, the RBA noted data had been “mostly positive” over the last month, having previously shown surprise at Australia’s positive March quarter GDP reading when the number became available last month. The board nevertheless continues to believe that business investment would “fall dramatically as a share of GDP over 2009 and 2010”, but only to levels still high by historical standards, and offset by the increase in stimulatory government investment.
For many months the RBA has insisted inflation would remain low into 2010 despite apparent signs of recovery, given lingering lower levels of capacity utilisation and higher unemployment. But with growth now expected to be stronger than first thought, and unemployment not as high as first thought, the board has slightly varied its view:
“The central forecast for underlying inflation was broadly unchanged in the near term, but the upward revision to the growth outlook meant that the trough in inflation was unlikely to be as low as had been previously expected. The staff forecasts now suggested that underlying inflation would fall to about 2 per cent around late 2010 and early 2011.”
If low inflation fails to linger as long as the RBA first thought, this only serves to bring forward the new tightening cycle.
The RBA always keeps an eye on the stock market in terms of making policy decisions, given it is a leading economic indicator. An improving stock market has been one reason why we haven’t dropped below 3% since the April cut, but last month when the board met we were looking at some June weakness in the rally. The story was different this month, and so the RBA can tick off another box as to why it won’t need to cut again.
So now the RBA has to look at the picture from a different angle. For the past few months it has been on hold with a 3% cash rate but always “standing ready” to make another cut if a wobbly economy needed one. Now it has signalled the end of the cutting cycle, the next problem is to know when to raise the cash rate. Leave it too late and inflation can get away, but move too early and the RBA risks stifling an early recovery:
“In discussing the timing and process of removing some of the current expansionary policy setting, members noted that it would, when it began, involve balancing two risks. There was a risk of overstaying a very accommodative setting in a recovering economy, particularly when underlying inflation still needed to decline to reach the target. On the other hand, there was a risk of an early tightening choking off confidence and demand prematurely. A particular source of uncertainty was whether the recent growth in household spending was due mainly to the temporary fiscal measures, in which case it would probably soon fade, a more general decline in risk aversion, or the more persistent effects of lower interest rates. Information over the period ahead would be important in judging this.”
The RBA will thus remain ever flexible as it balances its own policy decisions with that of the government.
Standard Chartered economists have reinforced the consideration today that as fiscal stimulus on the consumer side winds down, the risk is current strong economic data will turn weaker again. Moreover, Australia’s trade balance has been boosted by extraordinary Chinese commodity buying in the first half which will likely ease in the second.
Standard Chartered agrees that the RBA easing cycle is now over, but does not see the first rate rise until at least the June quarter of 2010. Some rival economists are already talking about the first rise being as early as February.
Read the full RBA minutes here.