The RBA prudently plays the waiting game

Caution reigns at the RBA as economic uncertainty grows at home and abroad. The exchange rate, the US taper and the timing of the mining investment cliff will continue to weigh on its policy deliberations.

It’s no surprise that today’s Reserve Bank minutes revealed the board is in a holding pattern, remaining cautious while it waits for some of the uncertainty surrounding US monetary policy to subside. Despite current record low rates, cuts are still on the table.

The RBA remains open to the possibility of reducing the cash rate further “should that be appropriate to support sustainable growth in economic activity”, while noting that the exchange rate “remained uncomfortably high and a lower level would likely be needed to achieve balanced growth in the economy”.

The minutes, from a board meeting two weeks ago, have been largely superseded by Reserve Bank governor Glenn Stevens’ interview with the Australian Financial Review last Friday. During that interview, Stevens downplayed the chance of a further interest rate cut in February at least.

Stevens is banking on a falling dollar giving Australia a boost. Although the dollar has declined significantly since the end of October, it still needs to decline further to facilitate growth in the non-mining sector.

Stevens quantified the Reserve Bank’s views on Friday, suggesting that the dollar needed to decline to around $US0.85 rather than its current level of above $US0.89. It marks a turning point in the RBA’s jawboning of the Australian currency given the central bank has previously avoided putting a number on what the exchange rate needed to be.

Stevens is likely to reiterate his comments tomorrow when he faces the House of Representatives’ Standing Committee on Economics. I will be interested in hearing his thoughts on the Mid-year Economic and Fiscal Outlook. With government spending expected to be almost $18 billion higher than in the initial budget estimates (around 1.2 per cent of nominal GDP), that should push up growth significantly in the 2013/14 financial year. That said, Treasury’s forecasts are similar to the RBA’s ones from November, which predicted a weakening economy.

The Board said that it is “continuing to gauge the effects of the substantial degree of monetary policy stimulus that has been put in place”. Both cuts during 2013 are still flowing through the economy and will not have had a large effect on activity, yet we will still be waiting until well into 2014 before it is clear how successful the Reserve Bank’s monetary stimulus has been.

Housing activity has picked up a bit, with dwelling investment set to rise on the back of widespread growth in building approvals. However, overall dwelling investment remains fairly weak. Even with a significant pick-up it will not be a major driver of growth in 2014.

The near-term outlook for the Australian economy appears to come down to three primary and interrelated factors:

1.       Exports. Resource exports are expected to pick-up in 2014, as the substantial mining investment that has driven growth recently turns into production.

2.       Lower exchange rate. This will be necessary to support growth in the non-mining sector and boost exports across the board, and will largely depend on the timing of the Federal Reserve’s taper of their asset purchasing program.

3.       A slower-than-expected decline in mining investment. At some point the mining investment cliff will arrive, but we have no idea when. The key for the Australian economy is ensuring that there is enough momentum in the economy to offset this decline when it occurs. The Reserve Bank will be hoping that the cliff can be delayed until after 2014.

There remains considerable uncertainty surrounding the economic outlook and the tone of the Reserve Bank minutes reflects this. Based on the minutes it is impossible to detect how the bank is leaning and what the next move might be. That seems entirely reasonable given current economic conditions, the timing of past rate cuts and the uncertainty surrounding the Federal Reserve.

With the Federal Reserve meeting on December 17-18, we may soon have a better idea about what the Reserve Bank might do. But for now, we – like the RBA – will just have to wait and see.

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