Australia: The RBA Drops Its Tightening Bias?

Although interest rate cuts are yet to be embraced

The RBA Statement on Monetary Policy dropped any reference to the fact that interest rates may need to move higher – recall the May SMP reference that “It would be surprising if interest rates did not have to increase further at some stage of the current expansion”.

Well, the RBA looks as if it was surprised by the weak economic activity and low inflation results of the last three months.

While an easing in interest rates is NOT explicitly flagged in the RBA commentary, the acknowledgment of ongoing weakness in domestic demand and a likely turning point in the labour market make such a move a possibility over the next six to 12 months.

The August SMP released today concludes that domestic demand has slowed and any significant re-acceleration in demand is “unlikely”. “The Board will continue to monitor developments and make such arrangements as may be required to promote sustainable growth in the economy with low inflation”. This sign off from the RBA encapsulates a scenario where interest rates will be cut if economic growth remains below trend and inflation pressures move to the low side. The story on inflation is a tough one with the “old” official inflation data up to the June quarter well contained, but the contemporary inflation news from the monthly TD Securities – Melbourne Institute Monthly Inflation Gauge showing inflation edging higher.

There can be little doubt that the RBA would have probably cut interest rates, like the Bank of England last week, were it not for the boost to national income and corporate profits from the boom in the terms of trade – “the global expansion is continuing to provide a favourable backdrop for the Australian economy.”

In looking for the words of the RBA that encapsulate the reasons why an interest rate hike is not longer on its agenda, “households now seem to have entered a phase in which they are '¦ borrowing less and increasing their spending less quickly than they were a year or two ago.”

On the business side, the RBA notes, “businesses seem to be in a good position to continue expanding their investment spending'¦ the good condition of the business sector has been reflected in the Australian share market, which has risen strongly this year.”

Inflation has clearly been lower than the RBA feared in March when it shocked the whole market with an interest rate rise. With headline and core inflation now running at an annual pace of 2.5%, the RBA acknowledges that the risks to inflation “are judged to be evenly balanced, whereas earlier this year they had appeared to be weighted to the upside”.

Working against a near term interest rate cut is the RBA judgment that “financial conditions do not appear to be inhibiting the growth of the economy at present. The current level of the cash rate is close to its historical average.”

COMMENT: Interest rates are on hold – watch the labour market and wages data plus news on global conditions and inflation to see which way they go next.

Stephen Koukoulas
Chief Strategist, Asia Pacific
TD Securities
Level 24, 9 Castlereagh Street
Sydney NSW 2000
AUSTRALIA
Tel: 612 9619 8846
Fax: 612 9619 8800
Email: Stephen.Koukoulas@tdsecurities.com