Reserve Bank Board meeting
- The Reserve Bank Board has left the cash rate at 4.75 per cent for the eighth straight month (covering seven formal meetings). The next meeting is on August 2 2011.
- The Reserve Bank has become more “dovish” – that is, it has backed away from rate hikes. Economic growth “is now unlikely to be as strong as earlier forecast.” And the Reserve Bank has reiterated its view that only a gradual lift in underlying inflation is “expected over time.”
What does it all mean?
- The Reserve Bank has discovered its “dovish” side, acknowledging the weaker outlook for the economy and inflation. You only lift interest rates if you feel that a strongly-performing economy will generate inflationary pressures. And that is clearly not the case at present. Employment has been falling, home prices are going backwards and consumers refuse to spend. As a result, most businesses are cutting prices to move stock, resulting in lower margins and profits. And as a consequence, the underlying rate of inflation has continued to fall – not rise – hitting a 6½-year low.
- The Reserve Bank finally gets it. While the Bank continues to note the positive broader benefits to the economy of the ‘terms of trade’ boom, it realises that people can’t see the gains. For instance our trade surplus with China has increased by over $14 billion over the past year or around $650 for every man, women and child. Now if those dollars were actually paid out, it may be different. But the increased profits for miners boost share prices and dividends and are reflected in the average worker’s compulsory superannuation. Unfortunately for many people they won’t see those gains for 30 years.
- For the past 14 months consumers and businesses have been on tenterhooks, bracing for the Reserve Bank to lift interest rates. But the Reserve Bank Board has seen fit to lift rates only once in that 14 month period. And, in hindsight, that decision is looking more and more questionable.
- A nirvana situation would be where a boom in mining areas was offset by weakness in consumer spending in capital cities, leaving the Reserve Bank with nothing to do but monitor the situation. It may not be nirvana, but so far that nice balance between hot and cold areas of the economy has been playing out.
- Last week we changed our interest rate views. It turns out to be the right move. Previously we envisaged that rates could rise twice over the second half of the year, but now we are only pencilling in one move over the next five months. The Reserve Bank is weighing up a number of factors and much depends on how the balance of forces behaves.
Interest rate decision and past cycles
- The Reserve Bank Board has left the cash rate at 4.75 per cent for the eighth straight month. In October 2009 the cash rate stood at a 49-year low of 3.00 per cent. But then the RBA embarked on a process to remove the emergency stimulus, lifting the cash rate by a quarter of a percent in October, November and December 2009, and then in March, April, May and November 2010. There has been only one rate hike in the past 14 months.
- In the last rate-cutting cycle the cash rate fell to a low of 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
- In response to funding pressures, banks were forced to lift rates above the cash rate. As a result, the Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.80 per cent, well above the long-term average or “normal” rate of 7.15 per cent.
- Financial market pricing suggests that there is a 17 per cent chance of a 25 basis point rate hike within the next five months. Most economists tip at least one rate hike over the coming year. Conditions can change quite quickly – a case in point was when markets factored in a rate cut after the Japanese earthquake and tsunami. CommSec currently factors in just one 25-basis point rate hike over the remainder of 2011 but this would require signs of stronger economic growth and higher inflation for the forecast to be validated.
What are the implications of today’s decision?
- The focus now shifts to June quarter inflation data (Consumer Price Index) to be released on July 27. The TD Securities/Melbourne Institute Monthly Inflation Gauge has indicated that underlying inflation stands at a 6½-year low of 1.6 per cent. If that result is reflected in the official inflation data then the Reserve Bank will have no reason to move rates in any direction.
- The extended period of interest rate stability should benefit housing-dependent companies. In the building materials sector our analysts have BUY recommendations on Adelaide Brighton, CSR and James Hardie. Our analysts also maintain a BUY rating for REA Group. Our analysts continue to favour Consumer Staples over Consumer Discretionary stocks with BUY ratings on both Wesfarmers and Woolworths.
The Statement
- The statement from today’s July 2011 meeting is below. Emphasis has been added to significant changes in wording in the recent statement.
MEDIA RELEASE
STATEMENT BY GLENN STEVENS, GOVERNOR
MONETARY POLICY
At its meeting today, the Board decided to leave the cash rate unchanged at 4.75 per cent.
The global economy is continuing its expansion, but the pace of growth slowed in the June quarter. The supply-chain disruptions from the Japanese earthquake and the dampening effects of high commodity prices on income and spending in major countries have both contributed to the slowing. The banking and sovereign debt problems in Europe have also added to uncertainty and volatility in financial markets over recent months.
A key question is whether this more moderate pace of growth will continue. Commodity prices have generally softened of late, though they remain at very high levels. Despite the challenging international environment, the central scenario for the world economy envisaged by most forecasters remains one of growth at, or above, average over the next couple of years. A number of countries have tightened monetary policy but, overall, global financial conditions remain accommodative and underlying rates of inflation have tended to move higher.
Australia’s terms of trade are now at very high levels and national income has been growing strongly, though conditions vary significantly across industries. Investment in the resources sector is picking up strongly in response to high levels of commodity prices and the outlook remains very positive. A number of service sectors are also expanding at a solid pace. In other areas, cautious behaviour by households and the high level of the exchange rate are having a noticeable dampening effect. The impetus from earlier Australian Government spending programs is now also abating, as had been intended.
A gradual recovery from the floods and cyclones over the summer is taking place, though the resumption of coal production in flooded mines continues to proceed more slowly than initially expected. The recovery will boost output over the months ahead, and there will also be a mild boost to demand from the broader rebuilding efforts as they get under way, but growth through 2011 is now unlikely to be as strong as earlier forecast. Over the medium term, overall growth is still likely to be at trend or higher, if the world economy grows as expected.
Growth in employment has moderated over recent months and the unemployment rate has been little changed, near 5 per cent. Most leading indicators suggest that this slower pace of employment growth is likely to continue in the near term. Reports of skills shortages remain confined, at this point, to the resources and related sectors. After the significant decline in 2009, growth in wages has returned to rates seen prior to the downturn.
Credit growth remains modest. Signs have continued to emerge of some greater willingness to lend and business credit has expanded this year after a period of contraction. Growth in credit to households, on the other hand, has slowed. Most asset prices, including housing prices, have also softened over recent months.
Year-ended CPI inflation is likely to remain elevated in the near term due to the extreme weather events earlier in the year. However, as the temporary price shocks dissipate, CPI inflation is expected to be close to target over the next 12 months. In underlying terms, inflation has been in the bottom half of the target range, though a gradual increase is expected over time.
At today’s meeting, the Board judged that the current mildly restrictive stance of monetary policy remained appropriate. In future meetings, the Board will continue to assess carefully the evolving outlook for growth and inflation.