As expected the Board of the Reserve Bank decided to leave the cash rate unchanged at 3.0%.
However there was considerable encouragement in the statement for our near
term view that they will decide to cut rates by 0.25% at the next meeting
on March 5.
The most important justification for that expectation is around the
sentence in the final paragraph: "The inflation outlook as assessed at
present would afford scope to ease policy further should that be necessary
to support demand." Our experience is that use of that word "scope" in a
forward sense indicates a decent chance that the Bank will move at the next
meeting.
The discussion around the domestic economy was largely similar to the
discussion following the December Board meeting. That is, two extra months
of low rates have not provided the Board with much encouragement that
things are turning. For example, investment outside mining is still
described as "remains relatively subdued". The labour market is still
described as "softening somewhat and unemployment edging higher". And
consumer spending is described as "moderate growth".
On the other hand there is a modest uplift in the assessment of the housing
sector with house prices being described as "moved higher" compared to the
December assessment of "moving a little higher". The strength of car sales
is recognised for the first time: "the demand for some categories of
consumer durables has picked up". And the mild reduction in risk aversion
by savers is noted: "savers are starting to shift portfolios towards assets
offering higher expected returns".
Some new concerns emerge in the statement. Firstly, a sign that the Board
is concerned about the outlook for employment growth: "businesses are
likely to be focussing on lifting efficiency". And recognition of the weak
credit growth in both households and firms: "some households and firms
continue to seek lower debt levels". Despite a modest fall in the AUD and a
30% jump in the iron ore price since the last Board meeting, the Board
continues to note the high exchange rate in a context of the observed
decline in export prices.
The main motivation for markets beginning to price out further rate cuts is
around developments in the world economy. In previous statements, the
Governor had consistently described risks to the global economy as to the
down side because of Europe. He now qualifies that by talking about these
risks having "abated, for the moment at least". However, he notes that the
build-up in public and private debt still affords vulnerability to
financial markets.
The wording around China is a little more upbeat with growth being
described as "fairly robust pace", while he is more constructive around
prospects for the rest of Asia due to the improved overall global
environment. Surprisingly no attention is given to the recent upswing in
iron ore prices with export prices still being described as having
declined.
Conclusion
We expected that recent optimism around the world economy would not be
sufficient to change the Bank's clear bias to further cut rates. This
expectation has been confirmed more strongly in this statement than we had
expected. In qualifying the recent improvement in financial conditions it
is clear that the Board does not believe that the global economy is on a
sustained upswing.
Commentary around the domestic economy highlights new concerns around the
outlook for employment growth and credit while the description of the
housing market is hardly exuberant. From our reckoning we are also seeing
for the first time guidance that the Bank expects growth to be "a little
below trend over the coming year" – that is consistent with the current
forecast of 2.25 to 3.25% in the November Statement on Monetary Policy.
However it is interesting that this "below trend" concept is raised in this
particular statement given that has not been the practise in the past.
In May last year we forecast that the cash rate which at the time was 3.75%
would bottom out at 2.75% some time near the end of 2012 or the beginning
of 2013. Today's statement has given us considerable encouragement that
this last leg in the cycle is likely in the near term and we maintain our
call that another cut can be expected in March.
Bill Evans
Chief Economist
Westpac Institutional Bank
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