On balance, RBA defers to US drama

Perhaps one of the Reserve Bank's board members took a pack of cards or a set of Mahjong tiles into the central bank's meeting on Tuesday. The decision to hold the cash rate steady wouldn't have taken long.

As the Reserve board sat down on Tuesday morning, the US lower and upper houses were playing ping pong with the nation's finances.

By the time a 2pm (Australian-time) deadline for Congress to agree on a federal funding bill arrived and instructions for swaths of public service operations to shut down went out, the Reserve's meeting was over. The central bank's statement was issued at 2.30pm.

There's no doubt that it had some interesting local developments to discuss. It's just that the decision to hold was pretty much a fait accompli before it did.

Days after the board met on September 3 and left its cash rate unchanged at 2.5 per cent, the Coalition won the election with a clear majority, ending a period of political uncertainty that was depressing sentiment and activity. Sentiment has lifted, and if that translates to more activity, a rate cut becomes less likely.

As the directors met on Tuesday, RP Data-Rismark also showed capital city house prices rose by 1.6 per cent in September and by 3.7 per cent in a year, the fastest pace in more than three years.

Talk of a real estate bubble is hyperbolic, but the housing market is definitely responding to the cash rate cuts that have already been implemented. That also makes another rate cut less likely.

Encouraging retail sales data on Tuesday also argued against a rate cut. Sales rose by 0.4 per cent in August. Previous months were weak and the annual increase was an underwhelming 2.3 per cent, but the August rise was promising because it was fuelled by sales of discretionary goods - the things we want rather than the things like food that we need. Department store sales jumped, for example, by a heady 6.4 per cent, reversing a 7.9 per cent slide in July.

The Australian dollar, on the other hand, has been pulling in the other direction. It has risen by about 5 per cent in a month. More accurately, the US dollar has fallen, after last month's surprise decision by the US Federal Reserve to defer scaling back its $US85 billion a month quantitative easing cash injection for the US economy.

At about US93¢, the Australian dollar is still about 15 per cent lower than it was in mid 2011. It is, however, delivering less price competitiveness to Australian companies that export or compete with imports than it was at the end of August, when it was just above US89¢. A rising dollar makes another rate cut more likely.

The Reserve did point to a lift in sentiment in its statement on Tuesday. It also noted that the Aussie dollar was still 10 per cent lower than it was in April. Both are hints that it is more comfortable about the currency's strength, and more confident that the non-mining economy is starting to fill the growth gap a waning mining investment boom creates.

Domestic considerations were, however, being overshadowed by the looming US government shutdown when the board met.

The Reserve made no mention of America's political standoff in its statement, but it would be firing a shot in the dark if it moved before the implications of it are known.

If the Republicans continue to use the funding bill to hold off President Barack Obama's Affordable Care Act health insurance overhaul, non essential public service cuts will expand and US economic growth will be hit.

The impact is minor at first, but it grows. Essential government operations including defence will not be affected, but non-essential work will progressively be suspended at a cost of about 15 basis points of annual economic growth a week, according to Morgan Stanley's chief economist, Vincent Reinhart.

The slowdown, in turn, affects the Fed's QE retraction timetable. The markets still believe the slowdown will begin before year-end, but as it does it will also put a brake on growth. The likely start date is pushed out if the economy is already slowing.

Slower growth in America and a delay in the QE taper would both tend to push the US dollar down, and the $A-$US rate up.

Most importantly, however, the congressional brawl over government funding this year sets the scene for another Democrat-Republican argument about Congress' October 17 deadline to increase the US government's $US16.7 trillion debt ceiling.

If the ceiling is not lifted, the US will be on course for something that will cause high market anxiety even if it is only seriously threatened - a default on US government debt interest payments in mid-November.

Most people think the partial government shutdown is an exercise in brinkmanship on both sides that will be settled quickly, perhaps within a week.

If talks aimed at averting more self-harm in Washington continue to fail and the debt ceiling takes centre stage, however, a period of market chaos will be unavoidable. The Reserve and everybody else has to wait until the US melodrama plays out.

mmaiden@fairfaxmedia.com.au