Learning the language of rate cuts

Market denizens love to dissect central bank comments, and some central bankers enjoy the game. Former Federal Reserve chairman Alan Greenspan once joked that if what he said seemed to be clear, he had probably been misunderstood.

Market denizens love to dissect central bank comments, and some central bankers enjoy the game. Former Federal Reserve chairman Alan Greenspan once joked that if what he said seemed to be clear, he had probably been misunderstood.

Since the end of 2007 when it began publishing comments about all of its interest rate decisions, the Reserve Bank has been a straight shooter, however, and its reasoning for leaving the cash rate at 3 per cent on Tuesday shows a continuing intent to go lower if necessary.

The Reserve's descriptions of economic and market conditions are always instructive.

In 2008 for example, it followed up a quarter of a percentage point cut in September with a one percentage cut to 6 per cent in October. Lehman Brothers had collapsed and the world's financial system had been pushed to the brink between those two meetings, and the Reserve's adjective engine red-lined in the October announcement. Markets had taken a "significant" turn for the worse, there was "serious dislocation" in the interbank markets, "heightened instability" in others, financing was difficult even for creditworthy borrowers, global growth prospects had deteriorated and "an unusually large" cut in the cash rate was appropriate, it said.

The Reserve said the October rate cut did not "establish a pattern for future decisions" and that was a sobering truth. The market crash and the economic shock it was propagating were setting the agenda, and when the Reserve cut by another three-quarters of a percentage point in November it kept the adjectives flowing, saying financial markets were "turbulent", share prices were "volatile", exchange rate swings were "significant" and economies were displaying "significant weakness".

Similar words were deployed when it hacked one percentage point chunks out of the cash rate in December 2008 and February 2009, although the Reserve was by then also reporting early signs that monetary and fiscal easing around the world was getting traction.

Its language has waxed and waned since as the crisis has morphed into an enervating battle to bring down sovereign debt loads, but we've come a long way.

A glance at this year's statements confirms that governor Glenn Stevens and his central bank soldiers are in a more comfortable place, even though they have the cash rate as low as it was during the crisis.

Financial markets remained "vulnerable to setbacks" as the task of putting public finances on a sustainable task continued, the bank said a month ago, but downside risks to global growth had "abated", commodity prices had firmed, sentiment had improved, credit spreads had narrowed, and share prices had made "further gains".

It's a touch more upbeat about the overseas outlook in its latest statement, saying the downside risk to global economic growth has "lessened", and that sharemarkets have risen "substantially", even though they remain vulnerable to "occasional setbacks".

The key statements, unchanged since February, are that the Reserve thinks economic growth in this country will be slightly sub-par this year as the baton-pass from the resources sector to the rest of the economy occurs, that its 3 per cent cash rate is therefore "appropriate", and that there is room to take it lower, because inflation is the middle of its 2 per cent to 3 per cent target range, and perhaps headed towards the bottom of the range as job cuts by companies responding to subdued demand keep a lid on wage demands.

A rate cut isn't guaranteed. It will happen if it is "necessary to support demand", the Reserve says, and so far this year, it hasn't seen the necessity.

Sill, the Reserve doesn't leave statements about possible rates moves lying on the table lightly. It announced that it had room to cut before it did so in 2008, hinted that it was preparing to lift rates again just before it pushed them higher in October 2009, and signalled that slowing global growth and easing underlying inflation was creating room for rates to go down before it began the latest rate-reduction cycle in November 2011.

By saying again that it can go lower the Reserve leans on the value of the $A, but that's not the main game. After its fall from about $US1.06 in mid-January to about $US1.02 the $A is only about US4¢ above what the Reserve would regard as fair value.

What the Reserve is really looking for, beginning with Tuesday's December quarter economic report, is evidence of what stimulus its 1.75 percentage point cash rate cut since November 2011 has delivered, and signs that the non-resources economy can plug the growth gap the mining sector will leave later this year as its investment phase plateaus and then declines.

It will also see whether the big banks themselves take mortgage rates lower. The time for a unilateral cut is approaching, and after its "divorce" from the other three two years ago, NAB is the one in the gun.

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