- The Reserve Bank Board has left the cash rate at 4.75 per cent for the ninth straight month (covering eight formal meetings) – the most stable period for rates in five years. The next meeting is on September 6 2011.
- With that latest reading of inflation on the high side of expectations, the Reserve Bank wanted to send a clear message on interest rates. The RBA has made it clear that if rates were likely to move in any direction in coming months it would be up, not down.
What does it all mean?
- In July, the Reserve Bank adopted a more “dovish” stance, that is, it acknowledged the weaker outlook for the economy and inflation. In the latest commentary the central bank has returned to its more traditional “hawkish” language so that it is clear to all and sundry that it isn’t considering rate cuts any time soon.
- The Reserve Bank Board has carefully crafted the accompanying statement, making it clear that interest rate cuts aren’t on the agenda. But while the statement suggests that the Board considered whether further policy tightening was warranted at the latest meeting, this appears a case of jawboning. To have increased interest rates when a raft of indicators suggested that the economy was stalling would have been the definitive “courageous” decision. Rather the Reserve Bank hopes that its latest attempts at jawboning do the work for it, that is, people get the message the RBA is worried about inflation, preventing it from actually having to go down the route of lifting rates.
- While the Reserve Bank has adopted a more “hawkish” stance in the latest statement, the slippage in domestic economic momentum is plain for all to see. Manufacturing and construction sectors are contracting, home prices have fallen for six months, housing borrowing is at 34-year lows, dwelling approvals and consumer sentiment are at two-year lows and employment growth is the weakest in 16 months.
- The Reserve Bank also needs to be mindful about the slowdown in the international environment with the US government cutting spending at a time when the economy is losing valuable momentum.
- The Reserve Bank has inserted a fresh, new paragraph dealing with overall financial conditions. The RBA says last year’s rate hike, lower credit growth, the high Australian dollar and falling asset prices all indicate that financial conditions are tighter than normal.
- We believe that the current softness in the economy is more of a temporary situation than something more entrenched. While consumers are not spending, this largely amounts to a reluctance to spend rather than inability to spend. Unemployment remains low and wages continue to outpace prices. As such, we think it is more likely that the Reserve Bank will lift rates in the future, but not before November.
Interest rate decision and past cycles
The Reserve Bank Board has left the cash rate at 4.75 per cent for the ninth straight month. In October 2009 the cash rate stood at a 49-year low of 3.00 per cent. But then the RBA embarked on a process to remove the emergency stimulus, lifting the cash rate by a quarter of a percent in October, November and December 2009, and then in March, April, May and November 2010. There has been only one rate hike in the past 15 months.
- In the last rate-cutting cycle the cash rate fell to a low of 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
- In response to funding pressures, banks were forced to lift rates above the cash rate. As a result, 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.
- Financial market pricing suggests that there is a 54 per cent chance of a 25 basis point rate cut within the next twelve months. But most economists actually tip at least one rate hike over the coming year. Conditions can change quite quickly – a case in point being the last month when financial market views have flipped from rate cuts to rate hikes. CommSec currently factors in just one 25-basis point rate hike over the remainder of 2011 but this would require signs of stronger economic growth and higher inflation for the forecast to be validated.
What are the implications of today’s decision?
- The focus now shifts to Statement on Monetary Policy on Friday. If the Reserve Bank feels that the community needs to be conditioned to expect higher rates in future, then it may start the “softening” up process with the commentary in the statement.
Source Craig James, Chief Economist, CommSec