Watchful RBA keeps open mind on rates

 

The Reserve Bank may have downgraded growth forecasts over the next year, however the accompanying commentary certainly suggests that Board Members are more comfortable than even just three months ago.

• The risks to the “global economy appear to be more balanced” while domestically the “significant monetary stimulus already in place, and signs of lower interest rates are having some of the expected effects.”
• In addition the Reserve Bank was at pains to point out that the average interest rate on outstanding housing loans is only “25 basis points above its 2009 low”.
• The statement certainly has an air of caution but generally the overall report card suggests the fundamentals for the domestic economy remain strong.
• Overall there are fewer ‘hot button’ issues on the Reserve Bank’s radar screen. However developments across the Eurozone – “where prospects for growth remain fragile” – seem to be the area that bares close scrutiny.
• The policy stance is clearly slanted towards the potential for further rate cuts rather than rate hikes. Instability in Europe; a high Aussie dollar; a lower terms of trade, coupled with a lack of non-mining investment are some of the potential triggers for another rate cut.
• Interestingly the Central Bank added a lot of emphasis on the China growth story, even discussing the territorial disputes between China and Japan. The key is no doubt the recovery in Chinese activity. If momentum in China gathers pace, it will support commodity prices and activity across the region – providing Australia with a stronger investment and consumption profile.
• Overall it is important to note that the Reserve Bank has provided the economy with substantial stimulus in the last year. And while the RBA has downgraded growth forecasts, the prior rate cuts are only just starting to have an impact across the economy. CommSec expects the Reserve Bank to remain cautious on its outlook but doesn’t expect any change in policy settings in the next few months. Confidence levels have improved, while the rally in share markets will support wealth levels and spending.

Key quotes and observations from the statement
Domestic economy to remain below trend growth:

• “The outlook for the Australian economy is slightly weaker than it appeared at the time of the November Statement. GDP growth is now expected to be a little below trend over 2013 before picking up a little in 2014. The revisions to the central forecasts for growth in the near term largely reflect information accumulating late last year suggesting that the outlook for mining and non-mining investment was a little weaker than had previously been thought.”
• “The forecasts for growth over the next year or so reflect several factors: the expectation that the mining investment boom will reach its peak; the effect of both fiscal consolidation and the persistently high level of the Australian dollar; and little sign of a near term pick-up in non-mining business investment.”
• “Overall, improving conditions in the housing market are expected to continue to provide support to dwelling investment.”

Global economy:

• “There have been further signs that the Chinese economy has stabilised, underpinned by public spending and accommodative financial policies. This has provided some additional support for commodity prices and activity in east Asia.”
• “Risks appear to be more balanced now for both China and the United States than was the case three months ago. Indeed, growth in the United States could well surprise on the upside if there is further timely progress on fiscal consolidation that avoids a sharp near-term fiscal contraction.”
• “There are many possible scenarios in which growth in Europe could be substantially weaker than is forecast, including the exit of one or more economies from the euro area itself.”

Interest rates:

• “Overall, the average interest rate on outstanding housing loans is now about 25 basis points above its 2009 low.”

Inflation:

• “…a continued softening in nominal wage growth and continued growth in productivity are likely to be required to keep cost pressures consistent with the inflation target.”
• “Inflation eased for a broad range of food items in the quarter, including bread, dairy items and some meats. This is consistent with reports that supermarket competition is continuing to restrain price increases, partly through putting downward pressure on supplier costs.”

Bank funding costs:

• “Relative to the cash rate, banks’ outstanding funding costs are estimated to have been broadly unchanged over the past three months. The relative cost of banks’ outstanding long-term wholesale debt remained stable over the period, with the large reduction in spreads for new bond issuance having only a minimal effect on banks’ outstanding wholesale funding costs at this stage. It will take some time for the reduction in spreads to flow through to overall bank funding costs owing to the relatively subdued growth in credit and the slow run-off of wholesale debt issued previously at higher spreads.”
• “Competition for deposits remains strong and deposits continue to be priced at a premium to wholesale benchmark rates.”

Forecasts & risks

• “The main identifiable source of downside risk continues to be the banking and fiscal problems in the euro area. European policymakers continue to work to address the underlying structural causes and alleviate some of the symptoms of the crisis, and in doing so have reduced the near-term risks.”
• “The forecasts for the Australian economy continue to embody a recovery in non-mining business investment, though it is expected to remain relatively low as a share of economic activity.”
• “There is also considerable uncertainty surrounding the outlook for public spending, given the large fiscal consolidation currently underway and planned by the Australian and state governments.”
• “Risks to the outlook for inflation reflect uncertainty about aggregate demand, the labour market, productivity and the exchange rate.”

Commodity Prices

• “Since the November Statement, the price of iron ore has increased significantly, reportedly in response to some restocking by Chinese steel producers after a significant drawdown in inventories over the second half of 2012. Other commodity prices have increased a little. However, forecasts of commodity prices in the medium term are mostly unchanged and so overall the profile for the terms of trade is largely as it was in the November Statement. Over time, the terms of trade are expected to decline gradually as the large amount of investment in the resource sector currently underway globally is likely to lead supply of bulk commodities to increase faster than demand.”
• “…given the recent pick-up in the price of iron ore, it is possible that the existing caution of miners could lessen and more projects be considered economically viable.”

What are the implications for interest rates and investors?

• The Reserve Bank remains watchful. There are few signs that the RBA is preparing to cut rates again in the short term, but arguably there are more events likely to result in lower rates than higher rates in the period ahead.
• The Reserve Bank has highlighted the substantial stimulus provided by lower interest rates and the resulting early signs of an improvement in activity.
• The RBA indicates that bank funding costs have not alleviated to any great degree over the past three months and at the same time there remains an intense competition for deposits. As such even if any rate cuts were to take place there remains the risk that not all of it may be passed on by financial institutions.
• CommSec expects interest rates to remain on hold over the next couple of months.