The minutes of the February 4 RBA Board Meeting confirmed that the Bank now has a neutral bias and has desisted from further talking down the AUD. On interest rates: "the most prudent course would likely be a period of stability in interest rates". Whereas in the December Board minutes the AUD was described as "uncomfortably high" the language used early in 2013 has been restored with "the exchange rates has also depreciated further since the December meeting. If sustained, a lower exchange rate would be expansionary for economic activity and would assist in achieving balanced growth of the economy". Of course that fall has not been sustained with the AUD around US 91c at the time of the December Board meeting falling to US 88c at the time of the February Board meeting but now having rebounded to around US 90.50c, only slightly below the "uncomfortable level" at the time of the December Board meeting.
Commentary around the domestic economy is generally upbeat. Consumption, dwelling investment, business conditions and exports are described as being "more positive". In fact the minutes note that "survey measures suggested that business conditions had improved noticeably in recent months, to be above average levels". Of course the labour market was still described as weak but this was partially dismissed by describing the labour market as a lagging variable. Consistent with that theme, and, in line with the view around spending, the minutes note that the forward looking indicators of labour demand had shown signs of stabilising although were described as "consistent with only moderate growth of employment". There appears to be little consideration in this analysis of the feedback effects from a weak labour market to household confidence and incomes. Indeed the Bank expects that the rise in house prices will boost spending leading to falls in the savings rate.
The unexpected increase in inflation clearly played an important role in discussions. Four different explanations were given for this lift with interestingly the first one mentioned being "an element of noise that occurs in economic data". Other explanations related to: the faster than normal pass through from the lower exchange rate: "a slower than expected pass through from weak wages growth"; and finally the possibility that there was less spare capacity in the economy enabling retailers or wholesalers to increase their margins. The Bank concludes that it was not possible at this stage to distinguish these explanations and it was likely that some combination of these four explanations was at work.
A number of vulnerable remarks appear in these minutes. Firstly, the 3% decline in consumer sentiment back to average levels made the comment "consumer sentiment had recorded a modest decline around the end of 2013" somewhat out of date. A more disturbing issue was around the Bank's forecast for growth of Australia's trading partners which is expected to increase to be above average in 2014. It would be our view that with Chinese growth likely to decelerate this growth outlook seems overly optimistic.
Conclusion
There are no significant surprises in these minutes. If the Bank had decided to continue talking down the AUD possibly with less strident language than "uncomfortably high" then it is likely to have been covered in the Governor's statement accompanying the decision two weeks ago. With no lead from the Governor it was not surprising that the language around the AUD has reverted back that period in 2013 when there was no explicit effort to talk down the AUD. The Governor also made it clear that policy had been moved to a neutral stance and these minutes confirm that view. There are a number of behavioural assumptions in the minutes. Firstly it is assumed that the labour market will lag economic growth with feedback effects from employment to incomes and confidence tending to be overlooked. It is therefore assumed that the rise in house prices will prompt a marked lift in consumer spending through the wealth effect and therefore a reduction in the savings rate. We tend to be more sceptical around that dynamic given the ongoing attitude of households since the Reserve Bank started to cut rates in November 2011. However we do accept the explanation that the unexpected lift in the inflation rate most likely shows some noise; a faster than expected response to the fall in the currency and a slower response to soft wages growth. With the AUD now stabilising and wages growth remaining soft the wages story is likely to be the dominant driver of inflation through 2014.
Our forecast that the RBA will need to cut rates further in the second half of 2014 clearly hinges on the likely outlook, at that time, for growth in 2015 . Factors that will impact on that outlook will include the ongoing downturn in mining; fiscal consolidation; the impact of a fall in the terms of trade; and two important macro dynamics which the Bank appears to be understating. These are the direct feedback effects on confidence and incomes of the weak labour market and ongoing caution amongst business and consumers.
Bill Evans - Chief Economist - Westpac Banking Corp
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