The Reserve Bank left rates unchanged at its board meeting earlier today, noting that despite a recent depreciation the Australian dollar "is still uncomfortably high". The tone of the governor’s statement was fairly neutral, which makes sense given the generally conflicting set of data that we have received recently. The bank doesn't meet again until February 4.
The economy appears tentatively poised right now, with enough signs that the rebalancing process is underway to be somewhat confident that the bottom won’t fall out of the economy but not enough signs to warrant raising interest rates.
On one hand, we have improving retail conditions and business investment intentions. On the other hand, dwelling price growth appears to have slowed in several cities and labour market conditions are far from optimal.
Building approvals have picked up significantly but remain low as a share of the population, and the major growth is in the less labour-intensive units segment. Business lending has improved but many firms continue to deleverage, while personal loans are on a downward trajectory.
For every plus in the economy right now, there seems to be a negative pushing against it and adding just that little bit of uncertainty.
But the biggest driver of uncertainty right now has nothing to do with the domestic economy. While the Reserve Bank is always monitoring domestic conditions, it will be directing an unusual amount of attention towards the United States right now.
The next move for the central bank will be dependent on the next move from the Federal Reserve. Its decision on when and how much to taper its assets purchasing program could send shock-waves throughout the global economy. On one hand a prompt taper will help the Australian dollar to depreciate but it may also have negative consequences for domestic asset prices and the growth of our major trading partners.
The Reserve Bank has been open about its desire to see the Australian dollar decline. Its jawboning activities have, so far, been successful and the Australian dollar has depreciated by 4.5 per cent against the US dollar since governor Glenn Stevens began his war of words on October 29. Stevens then ramped up his rhetoric during another speech on November 21. Today’s statement did not add anything new on the exchange rate front other than to remind the market that a further depreciation is necessary.
On balance, a prompt and coordinated taper should prove beneficial to the Australian economy. Right now we need a lower exchange rate more than we need elevated asset prices and provided that the taper does not occur too quickly then the Australian economy will adjust and be better for it.
But a slow and steady taper is required to ensure that there is not too much disruption caused to financial markets. Many feel that US stock valuations are out of line with their fundamentals, and I would agree, but a hard landing would only prove detrimental in sustaining the US recovery. I don’t envy the situation the Fed finds itself in.
Currently the Reserve Bank is in wait-and-see mode. The uncertainty right now was too great to make a move either way and it will be waiting until the uncertainty clears in the US before making its next move. The last thing the RBA wants to do right now is to make a policy move – either up or down – and then immediately reverse it. From the perspective of a central bank that is the type of decision that hurts their credibility. The downside of this view though is that if the Fed delays its taper indefinitely then the Reserve Bank could be left paralysed in no-man’s-land, facing an uncertain outlook with no clear policy direction.
So for the monetary policy watchers among us, the next stop is the US, where on December 17-18 the Federal Reserve will help determine what the next Reserve Bank move could be.