RBA Board minutes suggest "flexibility"

RBA Board minutes suggest "flexibility" on path to normal

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The Reserve Bank today released minutes from the early March Board meeting, during which members elected to restart the tightening cycle they unexpectedly suspended in February. The tone of today’s minutes was upbeat, as one would expect given that the Board hiked by 25bp, and did not reveal any material surprises. We continue to look for the cash rate to be 5% by the end of 2010 but, as highlighted by the Board minutes today, the prompt start to the RBA’s policy normalisation process in October last year has “subsequently allowed some flexibility” in the pace at which it proceeds. Thus, the precise timing of the Bank’s decisions going forward is highly dependent on the ebb and flow of the domestic data and events offshore. In our view, whether or not the RBA hikes again on April 4 remains a coin toss.

Back in February, when the RBA unexpectedly paused, it seemed the main reason was because Board members were uncertain about how households were coping with the three rate hikes already delivered (and the additional tightening by the Aussie banks). Today’s minutes reveal that, on balance, the domestic economic indicators have continued to point to a strengthening in economic activity. In fact, some of these indicators suggest that growth might already be running close to trend, where the RBA Board expects it to remain over the next couple of years.

On the domestic economy, the commentary was upbeat, as expected. The slew of economic data released since the last Board meeting four weeks earlier had tended to be “quite firm.” Board members noted that the labour market had remained resilient in January, with the unemployment rate having fallen 0.5%-points from its peak, but that workers’ hours had continued to fall. The Board meeting, though, took place before the release of the February labour force survey, which showed a spike in workers’ hours, which easily reversed the declines recorded in previous months. It was also acknowledged that the housing market remained buoyant and that consumption spending had held up reasonably well. That said, though consumer confidence remained upbeat, households appeared somewhat cautious toward spending.

Among businesses, outside of the mining sector, the RBA Board also acknowledged a degree of caution, such that investment in these sectors was likely to remain subdued. Mining sector investment, however, was expected to increase further from already elevated levels. Interestingly, members noted that it was unlikely that all planned mining projects would proceed at the rate that firms currently project, mainly owing to capacity constraints. In our view, with the economy likely to be bumping up against the same capacity constraints that blighted the last period of expansion due to under-investment in key infrastructure, upward pressure on inflation will build. Already, there are signs of skill shortages and wage pressure. That said, the RBA continues to forecast that inflation will be around the middle of the Bank’s target 2%-3% range over 2010.

On global conditions, the Board expects the global expansion to continue, but noted significantly divergences among regions. Economic growth remains strong in Asia, home to Australia’s largest export destinations, with most of the region’s economies reporting solid outcomes in the December quarter. Industrial production and exports, in particular, have been strong. In contrast, data from the US economy had been mixed and conditions in Europe remained weak. Regarding the fiscal problems in Europe, the RBA Board acknowledged that if these issues are not resolved “satisfactorily” there could be renewed turmoil in financial markets, which would have implications for the global economy and, therefore, Australia.

On balance, the RBA Board believes it remains appropriate for interest rates to move gradually towards normal levels. Indeed, additional official interest rate hikes are inevitable. We look for the next hike in the cash rate to come in May, with RBA officials using the intervening two-month period to gauge the strength of the domestic economy in the wake of the 100bp of tightening already delivered.

ENDS

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