Cash Flow Advantage Blog

RBA Board minutes

• Downside risks to global economy prompted Reserve Bank to cut interest rates: Minutes of the last Reserve Bank Board meeting confirm that policymakers were concerned about the strength of the global economy. 'It was likely that economic conditions in Europe would weaken further over the period ahead... The sovereign debt problems in the euro area posed the most significant risk to the growth outlook'.Given the threats to the global economy the Reserve Bank was focused on getting interest rates back to a more normal setting. 'Financial conditions had already been easing somewhat, with a range of lending rates edging down over the past couple of months. Nonetheless, with overall credit growth remaining low, financial conditions on balance appeared to remain somewhat tighter than normal'.

What does it all mean?

• Well it was hardly a surprise that there wasn't anything significantly new in the minutes of the last Reserve Bank Board meeting. Especially considering that since the rate cut and the accompanying statement, we have had the release of the Statement on Monetary Policy and also a speech by Reserve Bank Assistant Governor Lowe. If anything the minutes tend to confirm the view portrayed on November 4, when the Reserve Bank released its latest growth and inflation forecasts.

• It is clear that Board members have certainly become more concerned about the global economic outlook, focusing on heightened 'risks to the global economy'

• The European debt crisis dominated discussion and seems to be the key factor in the more flexible stance by policy makers when it comes to interest rates. Inflation is well contained and the Reserve Bank is focussed on a shift to more 'normal' financial conditions. At present the variable mortgage rate is still above 'normal' and if the risks to growth remain further rate cuts are likely.

• Interestingly the Reserve Bank spent time discussing the multi speed nature of the domestic economy. In fact the central banks expected mining investment to increase to around 7 per cent of GDP by 2013/14, while the non-mining sector was expected to grow below trend.
• Policymakers did highlight the importance and vagaries of the weather in defining the near term growth story. In fact the recovery in coal exports continued to be slower than the central bank had expected and a growing risk of a wetter than usual summer, could further delay the recovery in coal production.
• Overall, the Reserve Bank Board minutes paint a mixed picture of the Australian economy. The mining sector continues to dominate the growth outlook with a strong pipeline of investment, however conditions remained weak in the manufacturing, construction, wholesale and retail sectors. In addition Board members noted the softer housing market conditions. With all manner of diverging trends, and downsides risks to the global economy Board members don't appear to be entirely comfortable at present, and as such further rate cuts are likely.

What is the importance of the economic data?

• The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.

What are the implications for interest rates and investors?

• The lack of momentum in the domestic economy and the heightened risk of further weakness in the global economy certainly adds to the chance of a rate cut in coming months. The Reserve Bank Board seems focussed on shifting to a more neutral setting and given that the variable mortgage rate is still above neutral, a further rate cut is likely. The timing of the rate cut will depend on the volatility in Europe.

Source Savanth Sebastian, Economist, CommSec

RBA Statement on Monetary Policy

• The Reserve Bank has signalled that further interest rate cuts are a possibility, especially given that its previous forecasts for growth have now been downgraded, and inflation is now expected to remain within the 2-3 per cent target band.
• The RBA has warned that risks are weighted to the downside. Annual GDP growth forecasts in June 2012 have been cut from 4.5 per cent to 4.0 per cent. Underlying inflation is tipped to ease to 2.5 per cent in June 2012, down from 3.0 per cent
• Given that interest rates are at the high end of the normal range there is a high chance of an additional rate cut at the February board meeting. However any further rate cuts will largely be dependent on Europe. “The Bank's central scenario continues to be one in which the European authorities do enough to avert a disaster, but are not able to avoid periodic bouts of considerable uncertainty”.
• The Reserve Banks central forecast assumes interest rates are unchanged over the forecasts period but given “A materialisation of the downside risks would likely be very disruptive for Europe and could result in a deep recession” it may result in the Reserve Bank cutting rates earlier than anticipated.

What does it all mean?

• What a change three months make. The mood and tone of the Reserve Bank has changed from one of optimism to considerably more downbeat. Economic growth forecasts have been downgraded substantially while inflation is now expected to hold comfortably within the 2-3 per cent target band over the forecasts period.
• Interestingly the central bank has not highlighted much in the way of upside risks to growth forecasts. Rather the Reserve Bank goes one step further indicating the heightened downside risks to forecasts. The weakness in the domestic economy, slowdown in advanced economies and the threat that the European sovereign debt crisis gathers pace and adds to serious market volatility.
• The Reserve Bank is clearly focussing a lot more attention on global conditions, particularly given the concerns surrounding Europe. In fact any further rate cut is likely to be as a result of the volatility in Europe. It is important to point out that the longer it takes to find a solution to the European debt crisis the more heightened the risks are for the global economy. In addition a further rate cut would help to shore up domestic confidence and ensure that monetary policy move to a more neutral setting.

Reserve Bank Board meeting

• The Reserve Bank Board has cut the cash rate for the first time in 31 months. The cash rate was trimmed by 25 basis points (quarter of a percent) to an 18-month low of 4.50 per cent. The next meeting is on December 6 2011.
• In response to lower-than-expected inflation, the Reserve Bank concluded that there was scope to ease financial conditions. If passed on by banks, repayments on a $300,000 mortgage will fall by $49.10 a month.

• This is clearly the best news that many people have had in quite a while. The past year has seen the worst floods and cyclones in a generation, a European debt crisis, rising power and water bills and a rash of industrial disputes. So a rate cut will be warmly greeted by consumers and businesses alike. We are pleased that the Reserve Bank rejected its inherent conservatism, listened to the concerns of Australians, and delivered an early Christmas present.
• It is important to stress that the Reserve Bank is cutting rates from a position of strength, rather than weakness. The RBA can cut rates simply because inflation is under control, inflation is expected to remain under control and because financial conditions were a little too tight given the favourable position of inflation.
• Effectively the Reserve Bank has admitted that it got it wrong. In August the Reserve Bank was set to hike rates. But it has become abundantly clear that inflation was under control and financial conditions were tighter than necessary.
• Looking across the Four Financial Indicators (FFI) over the past month, it is clear that financial conditions have tightened. Dwelling prices continue to fall, the Australian dollar rose by US10 cents and 3-year swap rates have lifted almost 50 basis points. However credit growth lifted modestly over the past month. Overall, if the Reserve Bank hadn’t cut rates, consumers and businesses would have experiencing more challenging conditions.
• While rates have been cut, no one should expect a follow-up move any time soon. This rate cut may be similar to the reduction made in December 2008 – the only interest rate changed delivered in a 27-month period. Certainly the November rate hike of last year was the only rate change delivered in a 17-month period, so the Reserve Bank isn’t averse to remaining on the interest rate sidelines for an extended period.
• The Reserve Bank has signalled that it is more comfortable with economic conditions. The global economy has softened, the terms of trade has peaked and “inflation is likely to be consistent with the 2–3 per cent target in 2012 and 2013.”
• The Reserve Bank has now moved back to a more neutral stance – that suggests rates could move either way in coming months. If rates are moving anywhere in the short term, clearly it’s down, rather than up.

• The Reserve Bank Board has cut the cash rate for the first time since April 2009 – the first time in 31 months. The cash rate has been reduced by 25 basis points to 4.50 per cent.  The Reserve Bank had previously lifted rates seven times from October 2009 to November 2010 – a total of 1.75 percentage points, from 3.00 per cent to 4.75 per cent. Before today’s move, there had been only one rate hike in the past 17 months.
• In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. In the previous rate-cutting cycle the cash rate fell to 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
• The Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.80 per cent, well above the long-term average or “normal” rate of 7.15 per cent.
• Since hitting lows of 4.00 per cent on October 4, 3-year swap rates have lifted to 4.41 per cent.

What are the implications of today’s decision?

• For a more detailed explanation of the Reserve Bank’s decision, attention will now shift to the Statement on Monetary Policy, to be released on Friday. This report will contain the Reserve Bank’s latest forecasts on economic growth and inflation.
• Investors will need to carefully consider the implications of the rate cut. If banks pass the full rate cut on to borrowers, they are also likely to pass it on to savers in terms of lower term deposit rates. Dividend yields on bank stocks remain attractive, holding near 6.50 per cent, while the property market will receive a boost from the latest rate cut.
• The rate cut is especially good news for the beleaguered retail and housing sectors. But even tourism and export sectors receive a boost as the rate cut keeps a cap on the Aussie dollar.