The Fed (and the four?) keep the RBA quiet

It wouldn’t have surprised anyone had the Reserve Bank chosen to cut official interest rates again today. It is clearly still in a rate-cutting rather than rate-raising mode.

That it didn’t probably owes more to what the US Federal Reserve did, or rather said, last month, where the floating of a possible tapering of its quantitative easing program triggered waves of volatility through financial markets – and forced the Australian dollar solidly below parity.

It is the depreciation in the value of the dollar, which had been of increasing concern to the Reserve Bank, which probably caused the board to sit tight today, even though Glenn Stevens reiterated that the dollar still remains high considering the decline in export prices that has occurred over the past 18 months.

The dollar is being driven more by the actions or anticipated actions of foreign central banks, and the Fed in particular, than by anything the Reserve Bank has done. Despite the fall, the fact that the Reserve Bank still considers it to be overvalued leaves the bank with a continuing bias towards further easing of monetary policy.

There is no reason for it not to have that bias and plenty of reasons to expect more reductions in the cash rate.

Even with rates at historical lows, there is no evidence of a resurgent Australian economy to make the bank wary of further cuts.

Indeed, as the board noted, demand for credit remains subdued, unemployment is edging up and growth is below trend and expected to remain so in the near term. The Reserve Bank’s key concern – inflation levels – are not a concern, with Stevens saying that they had been consistent with the bank’s medium-term target and were expected to remain so ‘’over the next one to two years’’.

In fact consumer and business confidence has fallen back and in both the resource and non-resource sectors investment is falling away and a new wave of job-shedding and cost-cutting is getting underway.

Retailers are becoming very nervous about the outlook for retail sales over the rest of this year and, regardless of the outcome of the federal election (even though it appears a foregone conclusion) there is mounting trepidation in business about the nature and extent of the measures that the incoming government might be forced to take to reassert control of the country’s fiscal position.

It was interesting that, in an unusually brief statement, Stevens didn’t make the usual reference to the resources investment boom peaking this year – perhaps because the Bureau of Resources and Energy Economics recently published an analysis that suggests the peak may have been reached last year. Commodity prices have, of course, fallen significantly and it now appears the investment boom will taper off rapidly as projects that were on the drawing boards continue to get binned.

Stevens did say that the bank board judged that the easier financial conditions now in place would contribute to a strengthening of growth over time.

It is obviously still hoping that the 200 basis points of rates cuts over the past year-and-a-half and the break in the value of the dollar (roughly equivalent to another 25-basis point reduction in rates) will contribute to some rekindling of growth in the non-resource sectors of the economy, even though there is little sign of that occurring.

The bank is prepared to ease rates further if necessary to support demand, given it is comfortable with the outlook for inflation. With the cash rate at 2.75 per cent it still has, relative to most of its peers offshore, considerable firepower left in its armoury if it deems it necessary to try to give the economy some more stimulus.

It may also be trying to second-guess the actions of the major banks. Last month ANZ surprised most observers when it decided not to emulate its peers and pass on the full 25 basis points of the Reserve Bank reduction – instead cutting its mortgage rate by 27 basis points.

The weak demand for credit is starting to concern the banks and it is conceivable, with their average funding costs starting to finally trend down, that there could be something of a tussle for the available volume in order to drive some top-line growth.

It is possible that we might see some out-of-cycle rate cuts by the majors if there is more of a contest for market share, which would enable the Reserve Bank to retain its diminished firepower while the banks did the work of trying to stimulate some growth.