The Reserve Bank has not ruled out further interest rate cuts. Near term growth and inflation forecast have been downgraded, albeit mildly while the central bank remains optimistic about the longer term prospects for the domestic economy.
- The RBA has warned that risks are weighted to the downside. Annual GDP growth forecasts in June 2012 have been cut from 4.0 per cent to 3.5 per cent. Underlying inflation is tipped to ease to 2.25 per cent in June 2012, down from 2.50 per cent.
- The Reserve Bank has weighed into the debate on bank funding costs. The central bank highlighted the increase in wholesale borrowing costs and the shift in the composition of bank funding to shift to household term deposits – “which was now at its highest level since 1998”.
What does it all mean?
- After applying some major surgery to growth and inflation forecasts in November, the Reserve Bank has this time put away the scalpel and tinkered with a few minor cosmetic changes. In particular near term economic growth has been revised lower but the longer term growth prospects remain generally upbeat. In addition inflation is expected to ease further in the short-term, and remain comfortably within the 2-3 per cent target band over the forecasts period.
- The optimism that the Reserve Bank has shown in its longer term forecasts is largely due to the anticipated pickup in business investment over the coming. In fact the Reserve Bank believes that “over the next year the level of business investment in the economy will reach its highest level, relative to GDP, in at least half a century”. Despite it looking rosy the strength in business spending plans is driven by the mining sector and varies vastly across the states. In fact the clear driver of growth is likely to be Western Australia in line with the view portrayed in latest publication of CommSec’s State of the States report.
- The overall tone of the statement is one of cautiousness while highlighting the downside risks to the domestic economy. In addition the central bank did make clear reference to the exacerbated slowdown in the Euro zone and the fact that the growth in emerging economies is likely to be a little softer than previously expected. However while the Reserve Bank is cautious about the outlook it did make reference to the improvement in the economic landscape over the past couple of months – and that is the likely reason why interest rates were not cut this week.
- Interestingly the Reserve Bank is still open to the idea of further rate cuts, though it seems to be more a matter of timing. The likelihood of any further rate cuts will depend on the shifts in domestic inflation and the ongoing euro zone debt crisis.
- The recent media discussion on bank funding costs has prompted the Reserve Bank to shed some light on the debate. The central bank noted that the composition of bank funding has continued to shift to household term deposits, which was now at its highest level since 1998. However given the increase in competition for deposits, the Reserve Bank was well aware of the “increase in the spreads on term deposits”. In addition the spread on wholesale funding had “also risen due to an increase in the compensation required by investors globally”, while there was an “increase in the cost of foreign exchange hedging” due to the recent volatility.
- Unfortunately the increase in funding costs is unlikely to go aware anytime soon. Having said that it could have been a lot worse, in a positive perverse sort of way, the lack of consumer spending and resulting surge in the household savings ratio has allowed domestic back to shift the reliance away from more expensive international funding.
What is the importance of the economic data?
- The Reserve Bank releases its Statement on Monetary Policy each quarter. The Statement is the Reserve Bank’s assessment of economic and financial conditions and also contains the latest inflation views. The Statement is crucial is assessing the short-term outlook for interest rates.
What are the implications for interest rates and investors?
- The Reserve Bank is clearly focussing a lot more attention on global conditions, particularly given the concerns surrounding Europe. It is important to point out that the longer it takes to find a solution to the European debt crisis the more heighted the risks are for the global economy.
- From a domestic perspective it is clear that inflation is not a serious concern over the medium term. And if activity levels do not pick up over the next few months the Reserve Bank will once again cut rates in a bid to support and stimulate the economy. CommSec expects the Reserve Bank to shift to more accommodative policy in May – following the release of the next round of inflation data in late April.