Rudi's View | Aug 09 2010
By Rudi Filapek-Vandyck, Editor FNArena
One day God decided people on earth could do with another update. He sent out a signal to a selected group of followers that he would be appearing at a certain place, at a certain time. After he had conveyed his message to what had appeared a congregation of eager, but nervous listeners, something odd happened.
A first group of people formed who started to spread the news that God himself had spoken to them, and his words were “Thou shalt love thy Lord, and thy mother”. Understandable, it was seen as confirmation that all men should honour their mothers who had given birth to them and who had guarded their health and their well-being throughout the early years of their lives.
But soon a second group of people appeared who believed the first group had it all wrong. They believed God had spoken “Thou shalt love thy Lord, and thy brother”, indicating war and conflict were against God's wish. People should thus treat each other with respect at all times and under all circumstances; they should honour and love each other, without envy, hate or any sense of conflict.
Then a third group of people returned from the event, spreading the news they'd heard with their own ears God saying “Thou shalt love thy Lord, and no other”. To them the message was beyond discussion: people should not allow themselves to become slaves of false masters including money, lust and addictive substances.
I borrowed the above principle from the Hadith, which is in essence a collection of sayings and stories of wisdom that form part of the legacy and studies relied upon today by religious muslims. I see a parallel with how the Reserve Bank of Australia's message has been received by economists and by journalists since May this year.
Let me first explain how I have read the message from the RBA since the last rate hike in May this year: Firmly on hold.
I share this conclusion with colleague Greg Peel so one could say FNArena has been the only one around who has “heard” the RBA's message no further interest rate hikes should be expected for the foreseeable future, unless the Board's hand is forced through an unexpected (and sustainable) hike in inflation.
This message, in my view, was again repeated, loudly and clear, in Friday's “Statement on Monetary Policy”. Take, for example, the fact the RBA Board explicitly states it “will continue to assess developments in both the Australian and global economies and set monetary policy to achieve an average rate of inflation of between 2 and 3 per cent”.
Similar to earlier messages since May, the RBA acknowledges CPI inflation might print a number above 3% in the year or so ahead, but the underlying inflation, upon which the Board makes decisions whether the official cash rate at 4.5% is appropriate or not, is expected to remain at around 2.75% over the next year or so.
“Beyond the next year, underlying inflation is expected to gradually increase to around 3 per cent in 2012, reflecting capacity pressures in parts of the economy”.
Of course, and as acknowledged by the RBA in Friday's document, these so-called “central forecasts” remain subjected to a range of risks, both to the upside and to the downside. This is why sitting on the fence seems but a very appropriate position to be in at the moment. It's a luxury too, compared with central bank colleagues in most other countries.
Bottom line: Firmly on hold. No intention at this stage to change the official cash rate.
Yet, this is not how economists and journalists elsewhere read the same messages. Some economists are only prepared to acknowledge a September rate hike is now probably of low probability, but October and November remain penciled in.
Others are begrudgingly admitting there might be no action for the remainder of 2010, but surely early 2011 should see more tightening?
How about the RBA has no intention to hike any further for at least the next twelve months?
Journalists over the weekend have pointed out, again and again, that Friday's Statement refers to the market pricing in a small change to official interest rates, and that the RBA sort of embraces this fact as being appropriate. Hence their conclusion: the RBA is of the intention to hike at least one more time in the months ahead.
But, as shown in the next paragraph, this seems but a case of blatant biased reporting. Here's the paragraph everyone is quoting from (note how the second part is ALWAYS absent in reports elsewhere):
“The central forecasts are summarised in Table 14 and are based on the technical assumption that the cash rate moves broadly in line with market expectations. As noted in previous Statements, this technical assumption does not represent a commitment by the Board to any particular path for policy.”
In other words: the market currently only puts a low chance to any tightening in the months ahead, and to a maximum of 25 basis points for the year ahead or so, and the RBA acknowledges this seems more or less appropriate within the current context, but it doesn't mean the RBA Board's policy decisions will exactly copy these expectations.
Note these remarks are being made against a background that should see underlying inflation remaining inside the RBA's targeted 2-3% until mid-2012 (see the above mentioned Table 14 below).
Allow me to place the RBA's current mindset in a broader, historical perspective. At the end of the two previous tightening cycles the RBA went each time one step too far. Think about this for a second: in March 2008 the official cash rate in Australia was one more time lifted by 25 basis points. In hindsight, that was a serious error of judgment. As would become clearer a few months later, the worst global downturn since the 1930s was about to kick in.
The RBA has on both occasions received quite some criticism for these one-step-too-far policy actions. It is my view the Board has taken this criticism “on board” so to speak and it would very much like to do a better job this time.
Secondly, the RBA is also very much aware of history and the current buoyant environment for natural resources, boosting Australia's terms of trade, is far from unique. All previous similar booms have ended with a sharp bust.
The main danger for Australia, from a monetary policy perspective, is that the booming part of the economy (all things resources) will suffocate the non-booming parts. The RBA has developed a liaison with retailers throughout the country, the Board knows there's ongoing pressure for all companies relying on consumer spending.
Higher interest rates will only further lift pressure on these companies. This while it remains a matter of debate whether more interest rate hikes would actually impact on inflation given the contribution from “tradeables” to present inflation numbers is virtually non-existent.
This is why I believe the RBA would very much like to leave the official cash rate as it is for many more meetings than most economists, journalists and commentators in Australia are at present willing to acknowledge.
Most will tell us that as inflation will rise and rise in the months ahead, the RBA will again lift and lift again interest rates up to a full 100 basis points higher by late 2011. But this is NOT what the Board has been signaling since the May meeting.
Of course, and this is a clear and present danger which is mentioned in Friday's Statement: every economy consists of multiple moving parts, it may well turn out that inflation surprises to the upside in the year ahead. In that case, the RBA's hands will be forced to act.
But that is at this point not the central assumption (see Table 14 above).
FNArena does not calculate or estimate inflation numbers. Maybe this allows us to read every RBA statement without the predisposition that inflation is going to be higher pretty soon?
I'll happily spell it out: central bankers in developed economies, including Australia, New Zealand, the US, the UK and Europe (and probably China too) are firmly on hold. This is one of the reasons for investors to turn bullish on equities.
It not only means the removal of a key headwind, it also lifts expectations that low interest rates could provide these economies with a welcome boost, raising the odds for positive surprises in the year ahead.
I did take away one surprise from Friday's RBA Statement, though, and that is the RBA appears convinced the US economy is on the path of a solid and sustainable recovery. Personally, I find this surprising given the downward trend in data since April, but maybe I am making the same error on the US recovery as everyone else is regarding the RBA's stance on interest rates?
Certainly, it is from charts like the following one (page 10 from Friday's Statement) that market bulls draw confidence US jobs, and thus consumer spending, are only one more step away from the dire situation today:
Interesting question: does the RBA always know best?
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