• The RBA maintained its guidance that “the most prudent course was likely to be a period of stability in rates”.
• The tone was in line with previous Board minutes, highlighting the “significant degree of uncertainty” about the growth outlook.
• Trading partner GDP growth was expected to be slightly above its decade long average. But bulk commodity prices had fallen in the June quarter because of new supply from Australian producers.
• Firmer US activity and the US Federal Reserve’s reduction of financial assistance point to higher US interest rates next year.
• Businesses remain reluctant to commit to higher investment until they see signs of stronger demand.
• The RBA Governor will give his semi‑annual testimony to the House Economics Committee in Brisbane tomorrow.

It is worth remembering that yesterday’s August RBA Board meeting (and the minutes) preceded the more recent Statement on Monetary Policy (SMP). The SMP downgraded slightly the RBA’s GDP and inflation forecasts. It also included a relatively negative view on the labour market. Namely that the unemployment rate is likely to “remain elevated” and may not “decline in a substantial way till 2016”.

The Board minutes are very clearly “neutral” in their outlook for monetary policy. The forces acting against higher growth (like an overvalued AUD) are offsetting significant amounts of the benefits flowing from lower interest rates settings, such as a pick‑up in residential construction, and higher export volumes. The Board sees the conflicting forces operating currently as producing a “significant degree of uncertainty” around the growth forecasts. So the growth “transition” is underway. But the net effect is modest and not sufficient to lift GDP growth close to “trend” outcomes, ie 3¼%pa. More importantly domestic activity measures are well below trend.

The RBA’s views on the inflation outlook are, in our view, reasonably optimistic. They expect the “transition” to mid‑target band inflation as subdued wages growth reduces non‑tradables inflation to similar levels. It is clear that wages growth is subdued, running at just 2.6%pa in QII, the lowest in 16 years. But non‑tradables inflation remains stubbornly at 3%, which is at the top end of the inflation target band. Our take on the most likely way the economic data will evolve in coming quarters is more optimistic, growth‑wise, than the RBA. It has implications for our expectations on the most likely inflation outcomes as well.

It is worthwhile to note that financial markets are pricing in a 50% chance of a rate cut by mid‑2015. So the markets increasingly believe that the headwinds to growth will win the macro‑economic battle in coming quarters. They will be helped by a strong AUD which is negative for many sectors’ growth and employment outlooks. The restructuring forces imparted by the strong AUD are still considerable on activity levels and the inflation outcomes.

The RBA’s comments on the Australian dollar again point out the misalignment between significantly lower bulk commodity prices over the past year and the resilient AUD. Australia’s relatively high yielding interest rate securities, by international standards, are still attracting considerable offshore investor interest, despite the prospect of higher US and UK interest rates through 2015 and 2016.

We still believe that the question the RBA will be likely to debate early next year is “does it make sense to keep cash rates at record lows in an economy running near trend growth and where the desired growth transition is underway?”  We will have to wait for the next few jobs market figures to determine whether the July unemployment rate of 6.4% was an aberration or the new norm. If the unemployment rate falls back to 6% we would see it as supporting our argument.

Our somewhat ambitious call remains in place. We expect the RBA is likely to begin “normalising” monetary policy in early 2015.  The next major parts of the economic jigsaw are the QII Capex survey and, in the following week, QII GDP. Both have some downside risk. Even though the business surveys are showing higher confidence levels it is not flowing into better labour market conditions. The risk is that a sustained stronger AUD could impact on the inflation trajectory and the growth transition and therefore the timing of any ultimate interest rate move.

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