Australia's RBA Left Cash Rate Steady At 3%

Australia's RBA Left Cash Rate Steady At 3%

As expected, the Reserve Bank today announced a steady cash rate at 3% (J.P. Morgan and consensus 3%), following this morning's Board meeting. The commentary announcing the decision was broadly neutral, and indicates clearly that the RBA is in no rush to deliver further policy relief. It seems RBA officials are comfortable with the current policy settings, but the balanced tone of the message today leaves the RBA with sufficient flexibility to cut the cash rate again, should conditions deteriorate. In the near term, though, the RBA is leaving the policy stage to the Commonwealth Government, whose aggressive loosening of fiscal policy will extend into next week's Budget.

Almost all market economists expected no change today (market pricing indicated only a 16% chance of a 25bp rate cut) given the fact that, in particular, the RBA trimmed the cash rate only four weeks ago. With core inflation printing on the high side of expectations two weeks ago, and with RBA officials having talked up the path to global economic recovery since the last Board meeting, it would have been a significant surprise for the cash rate to be cut following today's meeting. Equally, the green shoots of global recovery have grown longer since the 7 April decision to trim the cash rate 25bp, and it seems that RBA officials want to leave Federal Treasurer Wayne Swan with clear policy air ahead of next week's personal tax cuts and spending increases.

Today's statement announcing the decision was broadly neutral, and hints that the RBA will be on hold for some time. On the plus side, the RBA mentioned the "signs of stabilisation" in the global economy, the "gradual" easing of the stresses in world financial markets (although confidence remains fragile), and the signs of a pick-up in borrowing by first home buyers. The statement, though, also was punctuated with negatives, which leaves the door ajar for further easing should the need arise. In particular, the labour market in Australia is deteriorating, and business borrowing is falling as firms curtail investment plans. On inflation, officials made clear that, even though it remains elevated, partly owing to rising import prices on the back of the drop in AUD since mid-2008, it probably will fall "gradually" in the period ahead.

One of the key drivers of the RBA's steady approach to lowering the cash rate in 2009 has been Board members' view that they want to see what impact the monetary and fiscal stimulus already delivered has on the economy. Once again, this was given prominence in today's commentary. With the RBA having delivered a mammoth 425bp of rate cuts since last September and, with the Government having tugged vigorously on the lever of fiscal policy, there is a mountain of stimulus in the pipeline. With households cautious, though, and with commercial banks reluctant to pass on official cuts through to market rates, there is considerable uncertainty about how much traction policy will get. It makes sense, therefore, for the RBA to remain on the policy sidelines until this becomes clearer.

Also, taking a measured approach to lowering the cash rate preserves policy ammunition in case it is needed later. Indeed, from a political perspective, Board members probably enjoy having the option of delivering modest interest rate relief as unemployment soars. Our forecast for the jobless rate remains 9% during 2010, although there now is upside risk to this forecast. The RBA's internal forecast for the jobless rate is very likely to be pushed higher, particularly now that the Governor has admitted the economy is in recession. We anticipate significant downgrades to the staff economic growth forecasts in Friday's Statement on Monetary Policy.

Our forecast remains that the RBA can afford to spread further policy support over an extended period. We expect a 25bp rate cut in August, and another 25bp reduction towards the end of 2009. These moves will take the target rate down to 2.5%, which we still estimate will be the terminal rate for this cycle. An important swing factor on our forecast, however, is the degree to which rising bank funding costs, which limited the extent to which the April rate cut was passed through to mortgage rates, persuade the commercial banks to retain the benefits of a lower cash rate. The RBA may be required to deliver more interest rate relief than we currently forecast if these banks look likely to pass on an even smaller portion of the official rate cuts later this year. Since the April decision, two domestic banks actually raised their interest rates on fixed rate mortgages.

ENDS

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