RBA rate decision: A modest move with more to come
Guest Post: by Dr Stephen J Nash
As expected, the recent RBA statement (the Statement) indicated that the cash rate was lowered by an expected 25bps from 3.75% to 3.50%. While we initially expected no change this month, developments in Europe, combined with a weaker than expected level of growth from the US, led us towards the idea that an easing was appropriate, yet only 25 bps. It is also worth noting that when the RBA moves, it typically moves over consecutive periods and the growth and inflation numbers allow adequate room for further easing of interest rates.
Despite this current easing, the yields on term deposits and longer term debt remain attractive, especially given the widening in credit spreads of late, meaning that corporate debt is returning more than double the government rate in most cases. Lower government bond yields mean that financial markets expect low growth, which, in turn, means that equities should continue to do what they have of late; add risk and not return to investment portfolios.
The following points are evident from the statement:
Global growth was seen as to have slowed more recently, and is expected to stay below trend. Importantly, regional growth was seen as remaining subdued as the RBA indicates;
Growth in the world economy picked up in the early months of 2012, having slowed in the second half of 2011. But more recent indicators suggest further weakening in Europe and some further moderation in growth in China. Conditions in other parts of Asia have largely recovered from the effects of last year’s natural disasters, but the ongoing trend is unclear and could be dampened by slower Chinese growth. The United States continues to grow at a moderate pace. Commodity prices have declined lately, though they are mostly still high.
Financial market sentiment was acknowledged to have deteriorated of late with global bond yields, including Australian yields, falling to “exceptionally” low levels,
As the exchange rate falls, the RBA acknowledged that there may be some pressure on inflation. As the RBA note;
There have been no new data for inflation since the previous meeting. Over the coming one to two years, and abstracting from the effects of the carbon price, inflation is expected to be in the 2–3 per cent range. In the near term, it is likely to be in the lower part of that range, though maintaining low inflation over the longer term will require growth in domestic costs to slow as the effects of the earlier high exchange rate wane.
In general, the current level of employment remains firm, which may, at some point, translate into higher wage claims, as the RBA indicated;
Overall labour market conditions firmed a little, notwithstanding job shedding in some industries, and the rate of unemployment remains low.
Unemployment remains close to a low 5%, and the tightness of the labour market remains a concern for policy makers, meaning that the decision to ease is not an easy one. Lower oil prices should drive improved growth in developed economies in the second half of 2012, and lower US rates should aid that procedure of growth, as evidence of a stabilization in the US housing market becomes more apparent.
Against this improved forward outlook for global growth, transmission of RBA moves should also improve going forward. Specifically, since major banks have recovered roughly 25 bps in funding costs from the recent series of easing, the transmission of easing should proceed with less dilution than on prior occasions. This means we should see a greater percentage of the change, as provided by the RBA being passed through to mortgage holders. Greater pass-through should also stem declines in consumer sentiment, at least in the short term, which should then stabilize the housing market.
This month, the RBA did what the market expected and eased interest rates, and indicated that the stance of policy is now “accommodative”. While the doves had expected another 50 bps, one has to acknowledge the risks are large with a declining exchange rate and an unemployment rate near 5%. Looking forward, the scope for further easing in monetary is apparent, with a low target of around 3% by the end of the year seeming to make sense at this time. Risks to this modest outlook for easing are many and varied, and include a material fall in the value of the Australian currency, and further tightness in the labour market.
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