RBA Releases SoMP, Some Inflation Forecasted

The RBA today released the quarterly Statement on Monetary Policy (SoMP). As we had expected, the tone of the commentary was very similar to that of the policy announcement following the Board meeting on Tuesday. The commentary indicates that while officials are keen to remove the "emergency"component of accommodative policy settings, they will do so gradually. This leaves room for the RBA to pause in December if, for example, economic or financial conditions take a turn for the worse. Our forecast remains that the RBA will raise the cash rate again in December, and again in February 2010, but the chances of a pause have risen.

For graph with data please see the following link: (http://img.scoop.co.nz/media/pdfs/0911/JPMorgan611.doc)

With the tone of today's commentary as we had expected, the main takeaways are that the RBA raised the official GDP growth and inflation forecasts, but the upgrades are unexpectedly small. The RBA now believes that the trough in core inflation will be 2.25% in late 2010, up only slightly from the 2% low expected in the last SoMP back in August. Our inflation forecast is higher, with the expected trough closer to 3%, at the top of the RBA's 2-3% target range. If we are correct, this will hardly be an encouraging point from which to start an economic upswing, particulary as Governor Stevens mentioned in his speech last night, and again today, that the economy has less spare capacity than earlier thought likely. Capacity constraints will, therefore, emerge quickly.

Our call for a December hike is on the basis that the cash rate remains too low given the economy's unexpectedly healthy momentum, even after the two recent hikes. That said, the case for a near term pause was strengthened by Wednesday's soft retail sales report for September, which hinted that households are sailing into headwinds in the post-fiscal stimulus world. An unexpectedly weak employment report next Thursday could be enough to convince officials that they should wait until early 2010 before tightening again. The main argument for raising the cash rate, however, has been that the emergency cash rate setting no longer was appropriate. This remains the case, so it would take material downside surprises on the data to deliver a pause.

On the real economy, the comments today are an echo of the policy announcement on Tuesday. Global economic and financial conditions have improved, particularly in Asia. As was the case on Tuesday, the particular strength of China's economy was highlighted today. On the domestic economy, today's statement ticked the same boxes as the Board did on Tuesday. The business investment outlook is improving, housing activity is picking up, and the labour market has been unexpectedly resilient. The main note of caution is over the outlook for business credit, owing to financing constraints. The official forecast is that GDP growth in the year to June 2010 will be 2.25% (up significantly from 1.0% previously). The economy should expand 3.25% in the year to June 2011.

On inflation, the SoMP assumes that the lagged effects of the economic slowdown, subdued wage growth owing to higher spare capacity in labour markets, and the disiflationary impact of elevated AUD will contribute to lower core inflation in the near term. Today's statement, though, describes some of the impacts on inflation as temporary. Officials, therefore, forecast that underlying inflation will be accelerating in 2011, albeit modestly. The RBA's forecasts assume an AUD of 91 US cents over the forecast horizon, and crude oil prices of US$85 per barrel. The forecast also makes the technical assumption that the cash rate will rise gradually.

For the record, there were no clues on the near term policy outlook in Governor Stevens' speech on The Road to Prosperity last night, nor in the question and answer session that followed. In particular, Mr Stevens refused to be drawn on where the "new" neutral rate was, except to say that it was a long way north of the prevailing 3.5%. In the speech, the Governor addressed lessons to be learned from the crisis, and ran through some of the virtues for Australia's economy. These include booming exports to China and a swelling medium term business investment pipeline.

ENDS

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