Open Question: Future Adjustments To Cash Rate

RBA Board Minutes Show Pace Of Future Adjustments To Cash Rate An "Open Question"

The Reserve Bank today released minutes of the November 3 Board meeting, at which officials hiked the cash rate target 25bp to 3.5%. According to the Board minutes, the pace of future adjustments to the cash rate remained an “open question.” This, we believe, leaves the RBA scope to pause if, for example, there is a significantly weak patch of domestic or offshore data. In the absence of a material downside surprise on the data, however, we believe the RBA will deliver another 25bp hike in December. Indeed, the underlying message of the Board minutes is clear - it remains “prudent” that the policy accommodation put in place be “gradually” removed.

The RBA minutes highlighted that economic conditions, both here and abroad, were significantly better than had been expected when the Board lowered the cash rate to 3%. In this context, and with the economy operating with less spare capacity than originally expected, the RBA will continue to remove the “insurance policy” put in place to protect the economy against a sharper downturn. We consider that about 100bp of the earlier policy adjustment was the “emergency” component of the policy accommodation; this should be, on our forecasts, removed by February. Thereafter, the pace of tightening will slow, with the RBA allowing longer intervals between hikes to test the resilience of the domestic economy and assess how conditions are holding up offshore.

On the global economy, the Board minutes noted further evidence of expansion, with particular mention of China. Board members highlighted that growth in Chinese imports was helping buoy activity in other countries, and reflective of more domestic-led growth. Indeed, this bodes favourably for growth in Australia’s other major trading partners in Asia. Asian economies were generally growing at solid rates, with growth expected to be about trend in these nation’s in 2010, according to Board members.

On the domestic economy, while there had been limited data released in recent weeks, Board members acknowledged that the labour market data had turned out better than expected earlier in the year. In fact, the RBA made special mention of the September labour force survey (released last week), which provided more evidence that the downturn in the labour market had been relatively mild relative to earlier expectations. Consumers, though, have held up reasonably well in the absence of further government cash handouts and confidence had continued to firm. Other references were made to falling business lending (owing to larger firms accessing debt and equity financing in capital markets), a rise in credit to smaller firms, and the weak outlook for construction (thanks to tighter lending standards).

The RBA again highlighted that there was less spare capacity in the economy than had previously been expected, and acknowledged that survey measures of capacity utilization had recently picked up. That said, there was a reference made to the fact that medium-term production capacity was expanding, owing to the growing population and growth in capital stock. This may explain why the RBA expects inflation to be consistent with target in 2010. Inflation will also ease near term, thanks to softer wage growth and stronger AUD.

As per the RBA’s most recent Statement of Monetary Policy, officials believe that the trough in core inflation will be 2.25% in late 2010. Our inflation forecast is higher, with the expected trough closer to 3%, at the top of the RBA's 2-3% target range. If our forecasts come to fruition, it is not a particuarly favourable starting point as the economic upswing gathers momentum, particularly given the economy has less spare capacity than earlier thought. If that is the case, capacity constraints, when they do re-emerge, will do so quickly, reinforcing our view that the RBA will continue tightening policy throughout 2010.

ENDS

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