RBA Board minutes

• Triple A Credit rating: The Financial Review has reported in an “exclusive” today, that “Rating agency Standard and Poor’s is warning Australia’s prized AAA credit rating could be reviewed unless substantial cuts are made to the budget in coming years.”
• Consumer confidence falls: The Roy Morgan – ANZ weekly consumer confidence index fell by 3.2 per cent to 100.4 in the week to May 18. The index has fallen 14 per cent over the past four weeks.
• Reserve Bank Board minutes: Board members “considered that the current accommodative stance of policy was likely to be appropriate for some time yet.”

What does it all mean?

• All politicians must take heed of the warning by Standard and Poor’s on Australia’s credit rating. Unpalatable choices must be made to the structure of Australia’s pensions, benefits and support payments as well as Australia’s tax structure. The Budget must be passed and bi-partisan agreements are needed on future spending and taxing – that’s what Australians believe that politicians should be doing. No Australian wants the economy to get in the same predicament as a raft of European countries. Australia’s economy is in good shape through good stewardship by Reserve Bank, Federal Treasury and governments of all persuasion over the past 20 years. It is important it stays that way. As former state treasurers acknowledge, the GST rate has to be increased or the tax broadened in coming years to address fiscal challenges with the ageing population. It is important that community discussion on the topic starts now.
• The Reserve Bank believes that everything is going to plan. That is, domestic conditions “had evolved broadly in line with earlier expectations.” In short, there is no need to change monetary settings. Rates are set to remain unchanged for a few more months yet.
• Before the Federal Budget was handed down the Reserve Bank Board observed “Over 2014/15, GDP growth was expected to be a bit below trend, with the effects of monetary stimulus partly offset by the downturn in mining investment and planned fiscal consolidation.” In other words, monetary policy is balancing fiscal policy. We will have to wait for the June Reserve Bank Board meeting to find out whether there is any change in emphasis and magnitude of this balancing act.

What do the minutes and data reveal?

RBA Board minutes

• The full-text of the minutes can be found here.

The key final paragraph:

• “At recent meetings, the Board had judged that it was prudent to leave the cash rate unchanged. The expansionary setting of monetary policy continued to have the expected effects on economic activity. Notably, a sustained increase in dwelling investment was in prospect, consumption had strengthened a little and business conditions were around average levels. Recent developments had indicated that the economy had evolved broadly in line with earlier expectations, resulting in little change in the updated forecasts for activity and inflation. With growth in activity expected to pick up only gradually, and spare capacity in the labour market consequently remaining for some time, growth in domestic costs was forecast to remain contained, which would help to offset the ongoing effect on prices from the depreciation of the exchange rate over the past year. Given this outlook for the economy and the significant degree of monetary stimulus already in place to support economic activity, the Board considered that the current accommodative stance of policy was likely to be appropriate for some time yet.”
  • The Reserve Bank says that the domestic economy “had evolved broadly in line with earlier expectations.”
  • The Reserve Bank says “Inflation was consistent with the target and was forecast to remain so over the next couple of years.”

Consumer confidence

• The authors report: “The ANZ-Roy Morgan Consumer Confidence fell a further 3.2 per cent to 100.4 in the week ending 18 May, after the 2014-15 Commonwealth Budget was handed down. Consumer Confidence began weakening noticeably four weeks ago when some significant policies were leaked ahead of the Federal Budget’s release and is down a sharp 14 per cent since then; the steepest decline over a four week period since the series became weekly in October 2008.”
  • The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.
  • The next interest rate decision on June 4 will be super-important. Not because of some imminent change in rates, but because the Reserve Bank will be able to give its judgement on the fiscal contraction associated with the Federal Budget and the implications that this poses for interest rate settings.
  • CommSec remains hopeful that Budget measures will pass the Senate; that confidence levels will recover; and that economic momentum won’t be adversely affected. We continue to expect the first interest rate hike this cycle to be delivered either late in 2014 or early 2015.
  • The Aussie dollar has lost a bit of ground over the last 24 hours on the warning by Standard and Poor’s. The progression of the Budget through the Senate is a short-term obstacle for the Aussie dollar.
  • The Budget wrangling has upset consumer confidence. In a macro sense the Budget isn’t a major drag on the economy but the perception of hurt from Budget changes is impacting confidence to a greater extent that the reality of the actual decisions.

What is the importance of the report?

• The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.

What are the implications for interest rates and investors?

• The next interest rate decision on June 4 will be super-important. Not because of some imminent change in rates, but because the Reserve Bank will be able to give its judgement on the fiscal contraction associated with the Federal Budget and the implications that this poses for interest rate settings.
• CommSec remains hopeful that Budget measures will pass the Senate; that confidence levels will recover; and that economic momentum won’t be adversely affected. We continue to expect the first interest rate hike this cycle to be delivered either late in 2014 or early 2015.
• The Aussie dollar has lost a bit of ground over the last 24 hours on the warning by Standard and Poor’s. The progression of the Budget through the Senate is a short-term obstacle for the Aussie dollar.
• The Budget wrangling has upset consumer confidence. In a macro sense the Budget isn’t a major drag on the economy but the perception of hurt from Budget changes is impacting confidence to a greater extent that the reality of the actual decisions.

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Australia Ratings also confirmed its product complexity indicator of ‘GREEN’ on the AUNs indicating that Australia Ratings considers the AUNs to be a debt investment with simple and straight forward terms and conditions.

“The ‘BBB+’ rating on the AUNs primarily reflects the assessed credit quality of both their issuer, Australian Unity Limited and the wider Australian Unity Group” said Australia Ratings’ credit analyst, Chris Cudsi. Mr Cudsi added, “In 2014, we expect Australian Unity to maintain the level of profitability achieved in 2013”.

AU’s earnings rose in 2013, as improved investment returns attributable to stronger asset markets offset significantly higher claims costs in AU’s health insurer. Net profit after tax (NPAT) for 2013 was A$29.4 million, compared with A$22.3 million for the previous corresponding period.

The Australian Unity Group is a diversified mutual specialising in the provision of healthcare (mainly, health insurance), financial services and retirement living.

The credit rating reflects the following key strengths of AUL’s business:

• Robust and competitive healthcare arm that generates over 60% of adjusted EBITDA
• Prudent and moderately conservative risk appetite with regard to gearing levels and maintenance of buffers above regulatory capital requirements
• Increasing diversification benefits of continued expansion into Retirement Living, Financial Services and Big Sky Building Society businesses

The credit rating also reflects the following key risks to AUL’s business:

• All three of the Australian Unity Group’s major businesses (Healthcare, Financial Services ‑ including Big Sky Building Society – and Retirement Living) operate in areas subject to significant regulatory scrutiny and/or political pressure to minimise price increases
• Increasing exposure to project and construction risks inherent in property development within the Retirement Living business
• Restricted financial flexibility, given Australian Unity Limited’s mutual status precludes future equity raising

The ‘GREEN’ Product Complexity Indicator of bonds is confirmed. A GREEN designation indicates the terms and conditions of the AUNs are simple and straightforward with a very low level of complexity on Australia Ratings’ five point Product Complexity Indicator scale.

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Rating Definition: Fund Credit Quality Ratings

Fund credit quality ratings, identified by the ‘f’ subscript, are assigned to fixed-income funds and other actively managed funds that exhibit variable net asset values. These ratings are current assessments of the overall credit quality of a fund’s portfolio. The ratings reflect the level of protection against losses from credit defaults and are based on an analysis of the credit quality of the portfolio investments and the likelihood of counterparty defaults. Fund credit quality ratings are identified by the ‘f’ subscript to distinguish the fund credit quality rating from a Standard & Poor’s traditional issue or issuer credit rating. A fund credit quality rating is not a recommendation to buy, sell or hold the shares of a fund. A ‘AAAf’ rating indicates that the fund’s portfolio holdings provide extremely strong protection against losses from credit defaults. A ‘AAf’ rating indicates that the fund’s portfolio holdings provide very strong protection against losses from credit defaults. An ‘Af’ rating indicates that the fund’s portfolio holdings provide strong protection against losses from credit defaults.

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