The latest Reserve Bank Board minutes suggests that the decision to cut interest rates in October was more to boost confidence rather than to address any significant structural downturn.
- The Reserve Bank Board members conceded that the ongoing slowdown in China and lack of significant stimulus by Chinese policymakers was behind the decision to cut rates. “Members noted that the gradual slowing of Chinese economic growth had been accompanied by declining exports to Europe for some time and, more recently, falls in exports to the United States and Japan…. The Chinese authorities had announced a number of infrastructure projects, although the additional stimulus that this imparted was likely to be modest in the near term.”
- A subdued inflation environment and downside risks to global growth will keep the Reserve Bank on an easing bias – “the outlook for inflation was consistent with the target over the next one to two years. Members concluded that the current assessment of the inflation outlook provided scope to adjust policy in response to the softer growth outlook”. As such CommSec expects the Reserve Bank to cut interest rates by a further 25bps in November.
- Total lending finance fell by 3.2 per cent in August to $49.3 billion – just off two year lows. Total lending commitments are down 14.8 per cent on a year ago. But loans to buy new cars were up 32.5 per cent on a year ago.
What does it all mean?
- The decision to cut interest rates by quarter of a per cent in October seems to have been more clear cut than markets previously thought. The latest Board minutes suggest the Reserve Bank seems to have a target rate in mind for interest rates over the medium term. In the past the Reserve Bank would cut interest rates and wait to see the impact on the economy. However this time round the minutes make clear reference to the fact that “it was too early to see the full effects of earlier reductions in the interest rates” yet members decided that a further rate cut was necessary.
- The low inflation environment ensured that Board members did not have to wait to see the full impact of previous rate cuts. They have been afforded the luxury of knowing that inflation looks well contained.
It is clear that rate cuts are not having the same impact that they would have in the past. In fact the sluggishness in the domestic economy has been more a crisis of confidence rather than a significant structural downturn. Even the minutes made reference to the fact “the desire of households to pay down their debts ahead of schedule”. In effect the rate cut was not going to send the economy into overdrive, rather it was a case of kick-starting confidence. - On the global front the slowdown in China was discussed at length with particular focus on the ongoing slowdown in Chinese exports to advanced nations. In addition the fact that no significant stimulus had been initiated by Chinese policymakers effectively meant the Reserve Bank had to step up to the plate and do some of the heavy lifting.
- Interestingly there was barely a mention in the minutes about the Australian dollar. For the last few months there has been a view across market participants that the strength of the Australian dollar was a big concern and a reason why the Reserve Bank would lower interest rates. However if that was the case the Reserve Bank would have had more of a discussion on the currency rather than just observation that it “remained high by historical standards”.
- Looking forward the Reserve Bank will continue to maintain an easing bias, however the urgency to cut interest is likely to have lessened given the recent rebound in commodity prices, pickup in share markets, life in house prices and a modest improvement in confidence. CommSec is still pencilling in another quarter of a per cent rate cut in November particularly given the downside risks to global growth – in particularly the slowdown in Chinese economic activity.
- The lending finance data is backward looking highlight the sluggish state of the economy around 3-6 months ago. The rate cut a fortnight ago will help to shift consumer and business views on confidence. As such it is likely that confidence will receive a boost in coming months.
What do the figures show?
China weakness
“Members noted that the gradual slowing of Chinese economic growth had been accompanied by declining exports to Europe for some time and, more recently, falls in exports to the United States and Japan. The slowing of growth in China had resulted in weaker demand for steel, which was evident in the falls in steel and iron ore prices in August and had resulted in lower steel production. The Chinese authorities had announced a number of infrastructure projects, although the additional stimulus that this imparted was likely to be modest in the near term.”
Decline in bulk commodity prices
“Overall, commodity prices were relatively flat in net terms over the month. The spot price for iron ore had recovered some of the sharp fall in August. In contrast, the spot price for coking coal had continued to drift lower. The prices for both commodities remained around 25 per cent below their levels in June. The terms of trade were estimated to have fallen further in the September quarter to be more than 10 per cent below their peak a year earlier.”
Patchy domestic economy
“Members noted that the labour market had been somewhat softer in recent months, although this was not inconsistent with earlier forecasts for the economy. Other recent data on economic activity had been broadly in line with earlier expectations about the pace of growth. Looking ahead, the forecast for GDP still anticipated mining investment making a significant contribution to growth in the coming quarters, with non-resource investment remaining weak, some possibility of an increase in dwelling investment, consumption growing broadly in line with incomes, and public demand subtracting from growth. Nonetheless, the information that had become available suggested there was an increased likelihood of growth over the coming year being somewhat weaker than earlier forecast.”
On housing activity
“Dwelling investment remained at a low level in the June quarter, although there were signs of improving sentiment in the housing market more recently. Members noted that weak dwelling investment had been at odds with the fundamentals for housing demand, as evidenced by the relatively low vacancy rate, below-average mortgage rates and ongoing population growth. They observed that, in some areas, developers had difficulties selling new dwellings given their prices relative to existing dwellings.”
RBA on inflation
“.. the outlook for inflation was consistent with the target over the next one to two years. Members concluded that the current assessment of the inflation outlook provided scope to adjust policy in response to the softer growth outlook.”
Outlook for rates
“Nonetheless, the information that had become available suggested there was an increased likelihood of growth over the coming year being somewhat weaker than earlier” … “at this meeting the Board judged that it was appropriate for the stance of monetary policy to be a little more accommodative, thereby providing some additional support to demand over the period ahead.”
What are the implications for interest rates and investors?
- Interest rates are below long-term averages, inflation is at the lower end of the target band, monetary policy is at a stimulatory setting and economic growth. All these factors allow the Reserve Bank time to get a more accurate picture of the economic landscape. The question is whether the bank has a target in mind for the cash rate. As such a November rate cut is still on the cards.
- The pullback in mining investment largely due to soft commodity prices and high project costs played a part in the decision to cut interest rates. Interestingly the Reserve Bank highlighted that the decline in spot prices would imply a sizeable fall in the terms of trade. Couple that view with the fact that inflation is expected to remain within the target band. And in line with Reserve Banks forecasts, it is clear that the Reserve Bank will continue to maintain an easing bias, allowing the Board to once again cut rates if it deems necessary. And given the downside risks to global growth, a further November rate cut cannot be ruled out.