• The Governor says that the economy in 2012 was growing close to trend or average but “the economy has entered 2013 at a pace a little below that”; inflation is low; the job market is balanced; housing activity is improving and the global economy is expected to growth at a trend pace. In short, the downside risks have diminished.
• The Governor said the high Aussie dollar has contributed to lower interest rates “If you were to ask me: is the cash rate therefore a bit lower than it would have been? The answer is yes, I would say.”
• The Reserve Bank Governor has delivered the clearest message yet that interest rates are on hold for some time. “Overall, there is a good deal of interest rate stimulus in the pipeline”…. “It is having an effect. Housing prices have been rising since last May, having declined for a period prior to that. Share prices have also risen quite significantly, and if anything by a little more than in comparable markets overseas”.
• The tone and comments from the testimony is consistent with CommSec’s view that the cash rate will remain on hold until at least mid-year and possibly even longer.

What does it all mean?

• The Reserve Bank Governor has delivered his clearest statement yet that interest rates are on hold at least until mid-year and possibly even longer. There wasn’t anything that was overly new in the Reserve Bank Governor’s commentary compared with what was released a fortnight ago in the Monetary Policy Statement. Rather his comments today provided more clarity and reinforced our view that interest rates are solidly on hold in the near term – especially given that the “substantial” stimulus measures are having an impact on the economy.
• The clear sense from today’s testimony to the Parliamentary Economics Committee is that Reserve Bank officials are extremely comfortable with current settings. Interest rate settings are well below a normal or neutral setting, but they are about right for the times. It is clear that the Reserve Bank is well aware of the multispeed nature of the domestic economy and the substantial rate cuts last year were not only to insulate the economy from the global risks but also to provide support to sectors affected by the stronger currency.
• Interestingly the Governor made the distinction that interest rates are not being used to achieve a certain currency level, rather “they are being set with recognition of the exchange rate’s effect on the economy”. In other words to ensure that sectors like manufacturing, tourism and exports are supported through loose policy settings. The Governor acknowledged that rates are at current low levels in part due to the high Aussie dollar.
• The Reserve Bank remains quietly confident that the Australian economy is on a sustainable recovery path. House prices are rising, share markets are healthier, population growth is strong and consumer confidence is more upbeat. In fact the Reserve bank is anticipating “that consumer demand will record growth roughly in line with the trend rise in income over the period ahead”.
• There is certainly no perception that the Reserve Bank maintains either an overly optimistic or overly pessimistic view. The Reserve Bank officials basically believe that they have settings right to handle future challenges. That doesn’t mean that there are no risks ahead – there always are. But the Reserve Bank Governor believes we are in a happy place.

Key aspects of the testimony
Interest rate outlook

• “The cash rate has been reduced six times over the past sixteen months, for a total decline of 175 basis points. Allowing for some change in the gap between the cash rate and other rates, lending rates nonetheless have fallen to be not far from their historic lows. The share of household income devoted to interest payments has likewise declined considerably. Indeed housing ‘affordability’ as conventionally measured, for purchasers, has improved a lot over the past two years”.
• “That represents quite a substantial change in policy settings. It is having an effect.”

Economic outlook

• “…while growth was probably about trend in 2012 as a whole, our sense is that the economy has entered 2013 at a pace a little below that. We have been inclined to think that the near-term outlook could be for more of the same, but things are likely to strengthen further out.”

Labour market

• “…the labour market softened in the second half of the year, with job vacancies declining, employment growth slowing, and unemployment increasing somewhat. Labour force participation also declined”.

Housing sector

• “Housing investment should strengthen given that several factors are supportive – interest rates are low, housing prices are tending to rise, gross rental yields have increased, population growth remains strong and is even picking up a little.”

Consumer demand

• “Our expectation is that consumer demand will record growth roughly in line with the trend rise in income over the period ahead.”

Terms of trade

• “Looking ahead, it appears that the peak in the level of resource sector investment is now close. It is a very high peak, but we do not think that there will be a rapid decline in the near term after the peak. However, it seems pretty clear that this type of investment will not be adding to demand for much longer.”

Aussie dollar

• “…as we have noted repeatedly, the exchange rate remains somewhat higher than one might have expected given the decline in export prices so far observed. This has been a relevant factor in the setting of interest rates. It is not that interest rates are seeking a particular exchange rate response, but they are being set with a recognition of the exchange rate’s effect on the economy.”

Monetary Policy Outlook

• “Overall, there is a good deal of interest rate stimulus in the pipeline. At its meeting earlier this month the Board judged that it was sensible to allow it time to do its work. The Board believed that the inflation outlook, at least as we assess it at present, would provide scope to ease further, should that be necessary to support demand. But for now, the Board decided it was prudent to sit still”

What are the implications for interest rates and investors?

• The Reserve Bank still maintains an easing bias, but it is no rush to act on it. What is clear is that the Aussie dollar is being watched closely. If the Aussie were to rise without higher commodity prices, further rate cuts could be delivered.
• Interest rate stability should be positive for consumer confidence and spending. The high Aussie dollar will continue to provide challenges for Australian businesses.

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