Australia | Aug 16 2011
By Greg Peel
It is fairly clear from the RBA's August monetary policy statement that the board approached the meeting with the intention of raising Australia's cash rate in a pre-emptive attack on inflation expectations, as it has been flagging for some months. However, just as the date was approaching global uncertainty reared its head once more.
The yields on Spanish and Italian government bonds had begun to blow out, and the US Congress was locked in a vicious battle over the US debt ceiling. On the night before the meeting Wall Street had fallen sharply on a weak manufacturing PMI result, and double-dip talk was once more all the rage.
“There was considerable uncertainty about how persistent the current slowdown would turn out to be; when the fiscal problems in Europe and the United States would be resolved; and what effect the ongoing market volatility would have on the global economy,” the minutes of that meeting, released this morning, noted.
It is now history that three days later, Standard & Poor's downgraded US debt sending global markets into a week of turmoil. But one might also argue that the downgrade itself is now history, given last night's trade on Wall Street saw stock markets recover to pre-announcement levels. Last week plenty of economists and traders in Australia convinced themselves the RBA was simply going to have to cut rates. Westpac has already led a charge suggesting weak economic data in Australia provided enough reason to cut anyway, and the futures markets have been discounting a cut for a while now.
The question is: Has the global picture changed markedly between now and August 2 – so markedly that the RBA would turn heel from being close to raising rates to deciding they should be cut?
The critical factor is noted in this statement from the minutes:
“Members considered whether the recent information warranted further policy tightening. The argument for tightening further was that underlying inflation had started to pick up and the central projection in the staff forecasts envisaged it rising above the target range during the forecast period.”
So really the question is: Have inflation pressures eased? At the meeting the board noted commodity prices remained elevated, and we note that there has been at least some pullback in prices since, although not marginally so given more recent rebounds (and not including gold of course). That would tend to leave the question as one of whether or not Australia's economy had appeared to slow sufficiently, outside of the resources sector, to imply easing inflation pressures. In his prediction that the RBA would soon be cutting rates, Westpac chief economist Bill Evans has drawn specifically from recent declines in business and consumer confidence. At its meeting, the RBA noted:
“Activity in parts of the economy was subdued, with consumers remaining cautious and business confidence having fallen somewhat. This was being mirrored in limited appetite for debt by both households and businesses.”
However it also noted:
“Overall, members noted that surveys suggested that business conditions, in aggregate, were around the average level of the past two decades and that the unemployment rate was at a low level.”
We have since had a slight rise in unemployment, but anything around 5% is still a “low level”. From these statements one might conclude that Australia's weak non-resource sector economy is not in itself enough to prevent the RBA from raising at this point, let alone to consider cutting. So that brings us back to global uncertainty.
Since the meeting, the US debt ceiling issue has been resolved for now, the ECB has moved in to shore up eurozone debt prices and the Fed has declared a zero cash rate for another two years. There are more decisions yet to be made on the European front but further assistance is expected. The S&P downgrade of US debt had been threatened for some time, so one doubts the RBA was at all shocked. And QE3 is not yet totally off the cards.
In concluding the meeting, the RBA noted:
“In considering the current stance of policy, members noted that although interest rates were only a little above average, credit growth had slowed over recent months and was very subdued by historical standards. Asset prices had softened and the exchange rate was high. While various other factors were affecting these variables, taken together they suggested that financial conditions were already exerting a reasonable degree of restraint.”
In other words, the weaker Australian economy was already doing the job a rate hike would be expected to do. The risk, however, was that:
“If the financial market turmoil continued, it could further weaken household and business confidence. This in turn could weaken the outlook for demand relative to the central forecast and, over the medium term, dampen the inflation outlook.”
It was on that basis the RBA decided to leave rates on hold for now and to continue to assess the outlook for growth and inflation.
The financial turmoil did continue, all through last week. Has it now settled?
Taking all into consideration, one might suggest that the case for a rate hike has now diminished in the foreseeable future. Yet given no noticeable dysfunction in Australian credit markets (Glenn Stevens noted this last week), the case for any “emergency” policy response is slim. Further turmoil had the potential to “dampen the inflation outlook'” the RBA suggested, not “turn it around”.
It is difficult to see a rate cut in September.
Read the full minutes here.
