"Balanced" RBA left cash rate steady as expected

Australia Economic Research

"Balanced" RBA left cash rate steady as expected

 
 
The Reserve Bank Board today left the cash rate steady at 4.5%, as we and the consensus had expected. This follows the 150bp of official rate hikes since October, moves the Aussie banks “super-sized” by as much as 25bp. The RBA’s (very short) commentary today announcing the decision was balanced, as we also had expected Indeed, today saw a marked toning down of the hawkish commentary from four weeks ago, which announced the RBA’s third quarter point hike in as many months.

Today’s statement indicates that the setting of monetary policy is “appropriate for the near term”. This simply is another way of saying that policy is “well placed for the present”, the phrase officials used in the minutes from the May Board meeting. While RBA officials clearly are taking particular note of recent troubling events in Europe, in no way does today’s commentary endorse current futures market pricing. Today’s pricing implies there is a non-trivial chance of the RBA cutting the cash rate in coming months.

On the contrary, while we suspect the RBA will leave the cash rate steady in July too, the Bank probably will resume the tightening cycle in August, following the release of the Q2 CPI report. This inflation report probably will deliver a rise in headline CPI of at least 1.0%q/q, and still-elevated readings on the core measures. While much of the rise in headline inflation will owe to the recent sharp rise in the tax on tobacco, the inflation “shock” will reinforce the argument that the RBA probably should not be leaving the cash rate steady for too long.

There are two main reasons the RBA paused today. First , today’s commentary made explicit reference to the evolving sovereign events in Europe and the relevant actions of the authorities. In fact, officials devoted two full paragraphs of today’s statement to the discussion on Europe. While Board members appear sanguine about the extent of a likely spill-over from financial market troubles to the real economy, it is clear that recent events in Europe nevertheless pose a risk to the global growth outlook; developments globally will remain “under review”.

Second , even though today’s statement makes no explicit mention of the consumer (or, for that matter, the labour market or house prices) there is mounting evidence that Aussie households have crossed the interest rate pain threshold, following official rate hikes at six of the previous seven RBA Board meetings. Consumer confidence plunged in May (having held up after the five previous hikes), with sentiment among mortgage holders falling the most. Also, anecdotes from retailers indicate that discretionary sales, in particular, have stalled. Similarly, yesterday’s RBA credit aggregates showed a slower rate of growth in credit to housing for the second straight month.

While the events in Europe, understandably, have become more prominent in RBA decision-making, the underlying position on Australia does not appear to have changed materially since the last rate hike in May. Indeed, with the RBA’s position already well known, the commentary on Australia spanned just three lines. It again referred to the stimulatory impact on national income and demand of the high-flying terms of trade. High commodity prices are a key driver of the filling investment pipeline. Interestingly, officials this time declined to make explicit reference to resources investment; it seems they want to steer well clear of the heated debate over the merits of the government’s proposed 40% tax on the “super profits” of mining companies.

On the global outlook, officials still believe economic conditions in Asia, where 60% of Australia’s exports are headed, remain “quite strong”. In fact, the statement hints that the authorities to Australia’s north probably should be taking action to slow growth in the region. The statement indicates that growth in North America is becoming “more established”. This seems to counterbalance the reference to the recent weakness in Europe.

On inflation, today’s commentary once again made clear that inflation will be in the upper half of the target range over the next year. In our view, the risks are to the upside. Indeed, the near 10% plunge in AUD in trade weighted terms since early May could place upward pressure on import prices in coming months. That said, there is evidence of heavy discounting among many retailers, who seem to have been left with excess inventories owing to the recent weakness in household spending. Without sufficient pricing power, retailers may chose to take the higher cost of imports as a hit to the corporate bottom line, instead of raising prices.

The RBA’s tightening cycle has paused, not ended. Indeed, our forecast calls for another quarter point rate hike in August, and for a further hike before the end of the year. The dominant risk, however, is that the RBA stays on hold for longer, but this would only occur if there is clear evidence that the events in Europe had caused a material spill over from financial markets to the real economy. Europe receives only 10% of Australia’s exports, but the case for further monetary tightening here would weaken significantly if growth in North America and, by extension, Asia, was threatened.

ends

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