Cash Rate Left Steady At 7.25%

Cash Rate Left Steady At 7.25%

As expected, the RBA has announced an unchanged cash rate following today’s Board meeting, following the back-to-back 25bp rate hikes in February and March, and the disproportionately large increases in interest rates by the commercial banks. The Board decided to leave the cash rate steady at 7.25%.

The tone of the commentary announcing today’s decision was balanced. Importantly, though, the RBA highlighted the risk that demand may not slow as expected. Officials believe that “in order to reduce inflation over time, growth in aggregate demand needs to be significantly slower than it was in 2007.” The RBA acknowledged today, however, that demand may not slow and “should expectations of high ongoing inflation begin to affect wage and price setting”, this outlook would need to be reviewed.

The RBA’s statement again emphasized the early signs of a slowdown in domestic demand, highlighting, in particular, the recent softness in household spending and demand for credit. There have been other signs that domestic demand is cooling, including weaker confidence readings and a fall in home auction clearance rates. This moderation has emerged in the wake of the 50bp rise in the cash rate this year and the accompanying increases in variable mortgage rates among the “Big 5” banks – these increases have been by more than, and sometimes outside of, moves in the official cash rate. There is, therefore, a significant amount of monetary tightening already in the policy pipeline.

The statement again acknowledged that conditions in global financial markets had improved in recent weeks, although still remain fragile, and that global growth will be below-trend this year. Even so, the soaring terms of trade will continue to provide significant stimulus to the economy. The RBA stated that the rise in the terms of trade that is currently occurring is much larger than had been expected a couple of months ago. The soaring terms of trade will provide significant support for domestic demand later this year, particularly for households via the national tax system; the federal government has used rising company tax receipts as a source of funding for five straight years of generous personal tax relief, and there is another round of tax cuts scheduled for July.

The RBA acknowledged today that there remains much uncertainty surrounding the outlook for demand and inflation given the opposing forces at work, but predicts that demand growth will remain moderate this year. The RBA highlighted that, although inflation will remain high in the short-term, the anticipated easing in domestic demand should help curb inflationary pressures. The risk is that the fiscal stimulus in the pipeline prevents the easing in domestic demand currently forecast by the RBA.

Thus, while “the current stance of monetary policy remains appropriate for the time being,” the door for further tightening has been left slightly ajar. Indeed, given the midyear personal income tax cuts, and rising wages owing to the drum-tight job market, it would take serious, adverse economic or financial market developments offshore to trigger an RBA rate cut this year.

Our attention is now focused on the quarterly Statement of Monetary Policy on Friday. RBA officials will explain in great detail the latest views on the economy and policy stance. As always, the focus should be on the inflation forecasts towards the back of the statement. The shocking 1Q outcome means the forecasts now have a much higher base, but the RBA probably will have a steeper decline back towards the target range. The RBA probably expects inflation, though, to stay above target in 2009.

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