July 2, 2014

RBA Annoucement: RBA still uncomfortably on hold

Predictably the RBA left the cash rate unchanged at 2.50%. They also retained their neutral bias – a small surprise – saying again that “the most prudent course is likely to be a period of stability in interest rates”.

  • We don’t read the unchanged rate and policy bias as signalling a lot of comfort.
  • They expect the economy to grow below trend and little doubt they’d prefer a lower $A. Equally, they are reluctant to cut what they call a “very low” interest rate.
  • The most probable outcome remains that they will be on hold for a long time. The growing risk to this view is that they may still need to cut again but: 1) the hurdle to cut again is high; and 2) the economy will need to be much weaker than it is now.
  • Governor Stevens gives a speech on Thursday.

The RBA left the cash rate at 2½% today and in a small surprise the Statement was as neutral as June. The vast majority of the Statement was unchanged from June and the key summary sentence identical – “On present indications, the most prudent course is likely to be a period of stability in interest rates”.

They’ve summed up policy this way for six consecutive months – Yawn!

The surprise element was that there had been a little bit of chatter (including from us) that they would soften their tone slightly to reflect some of the activity data having moderated as well as the $A being persistently high.

There was none of this. My reading saw only a couple of wording tweaks. They removed the sentence from June which read “the earlier decline in the exchange rate is assisting in achieving balanced growth in the economy“(dovish) but added a comment that business credit was now picking up (hawkish). Net on net, nothing.

So where are we left?

As we see it, the RBA continue to sit uncomfortably on hold.

The economy is not anywhere good enough for them to hike – they again noted “Overall, the Bank still expects growth to be a little below trend over the year ahead”, largely due to the fiscal headwinds and “resources sector investment spending (that) is starting to decline significantly”. The persistently high $A adds to their discomfort.

Evidently, they are also reluctant to cut what they say is “very low” interest rate. With the inflation outlook benign, and the economy sub-trend, I expect this reluctance stems entirely from a concern that even lower interest rates might pump up asset prices to unsustainable levels and cause consumers/businesses to re-leverage in an unhealthy way – they don’t use those words but that’s the gist.

For now this means the most probable outcome is that they stay at 2½% for a long time – this is NAB’s forecast. As we expect the economy to remain soft in the months/quarters ahead, the clear risk to this forecast is that they may need to cut again. What’s equally clear though is that the hurdle to cut again is high.

My three tests for the RBA to be satisfied a lower cash rate is necessary are: 1) inflation to be benign – it will be; 2) the economy re-weakening – most obviously by the unemployment rate starting to climb again; and 3) house prices need to be flat to falling. This last test would tell us present interest rate settings have stopped working their magic. House prices rising again in June tells we are not at that point yet.