Stevens holds on for a Fed miracle

The Reserve Bank was cautiously optimistic on an economic upswing, but until Federal Reserve tapering hits the dollar Glenn Stevens’ hands, to some extent, remain tied.

The Reserve Bank has been in a holding pattern for the past three months and is likely to remain there for some months to come. Nevertheless the statement from Glenn Stevens that detailed the outcome of the Reserve Bank’s latest board meeting was marginally more optimistic than in previous months.

That, and the decision not to shift rates, was not unexpected. Surveys are confirming the expectation that the outcome of the federal election – a return to a more conventional parliament, at least in the lower house – would see some pick-up in consumer and business confidence.

That modest but discernible improvement isn’t locked in. Stevens said on Tuesday, as he did last month, that it was still too soon to judge how persistent it would be. Tony Abbott has, however, largely succeeded so far in lowering the profile of politics and getting it off the front pages, which is a positive for confidence.

As Westpac’s Gail Kelly (who yesterday predicted a lift in the currently very subdued demand for credit) said on radio on Cup Day, if consumers start spending businesses will have more confidence to invest.

With the resources investment boom waning rapidly, that’s a pre-requisite for reasonable levels of economic growth. The most recent retail sales numbers suggest the process may have started, albeit cautiously.

The Reserve noted that there had recently been signs of increased demand for finance from households and continuing evidence of a shift in savers’ behaviour in response to the meagre returns on offer from low-risk assets.

Housing and equity markets have strengthened further, trends which should be supportive of investment, Stevens said. There has been surge in house prices in recent months, while the equity market is up nearly 30 per cent this year.

The previous rate cut of 25 basis points in August, which took the cash rate to an historic low, could have been the last in this rate cycle, but there are some caveats.

While the RBA noted that volatility in financial markets had abated, the future of the Federal Reserve Board’s quantitative easing program remains unresolved. Any time there is speculation of an imminent start to the tapering of that $US85 billion a month bond and mortgage-buying program the markets are thrown into turmoil.

When the Fed finally does begin tapering the markets are likely to be very volatile and there is some potential for unexpected consequences, given the scale and duration of the money-printing by the Fed since the financial crisis and the opacity surrounding what the markets have done with the near-costless liquidity pumped into the US system.

A likely outcome affecting the Australian economy if the taper does commence sometime in the next few months would be a lower Australian dollar, which the Reserve Bank wants desperately. There have been constant reference to the dollar in the bank’s public statements throughout this year, with Stevens describing its level today as remaining ‘’uncomfortably high.’’

‘’A lower level of exchange rate is likely to be needed to achieve balanced growth in the economy,’’ he said.

Versions of that statement have studded Stevens’ post-board meeting commentaries this year, although this time the language was if anything a little stronger.

The dollar ticked down quite sharply after the RBA statement, presumably because of the perceived strength of the language used – the ‘’uncomfortably high’’ phrase, although it is unlikely the bank would, given the way housing markets are taking off again, cut rates further to try to push the dollar down.

It needs the Fed to do that job for it, but the Fed – despite increasing concerns in the US about the corrupted and potentially dangerous incentives US monetary policy has created for investors – appears to be reluctant to push the button on a taper while the country’s economic growth remain sluggish and its fiscal settings, thanks to the peculiarities of the US political system, relatively contractionary.

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