The minutes from the November 3 Reserve Bank Board meeting have adopted a much more dovish style than we saw from the October minutes. Given that the Bank decided to only raise rates by 25 basis points following those October minutes, it appears that the strong language from October was most focussed on justifying the somewhat earlier-than-expected beginning to the tightening cycle, rather than revealing a high degree of urgency with regard to the tightening task ahead. In November, no such justification was required, given that the debate was really about whether the RBA moved by 25 basis points or 50 basis points. This moderate language can also be interpreted as supporting the more modest adjustment option.
Consequently, whereas the October minutes abandoned the key term "gradual adjustment", the word "gradual" is mentioned twice in the last three paragraphs of the key "Considerations for Monetary Policy" section. The most curious aspect of these minutes is the meaning of the final phrase "... though the pace of the adjustment remained an open question". It's reasonable to conclude that "gradual" refers to the size of moves, and "pace" the frequency of moves. Hence this phrase has most likely been used to discourage any expectation of moves every month.
However, we do not believe that it is significant enough to indicate that the Bank will not raise rates again on December 1. The data flow since this meeting occurred has been extremely positive. Following the surprise gain of 41,000 jobs in September, the market quite rightly expected some statistical correction in October, yet another large job increase was registered, with 25,000 new jobs being created in October. Housing finance approvals surprised with a 5.1 per cent increase in September, and business conditions registered a sharp improvement with a further gain in already strong confidence. In the minutes, specific reference was given to "consumer confidence could prove fragile". In the event, we did see a 2.5 per cent fall in consumer confidence in November, but in the context of its already near record level, and previous experience when confidence levels have fallen by 10 per cent or more following a rate hike, this consumer confidence result was solid.
The minutes are generally more positive about the global economy, noting that growth in Australia's major trading partners was likely to be around trend in 2010. Since then, we have seen strong data from China, and a further 7 per cent jump in the US share market.
On this basis, while the Bank has used the minutes to highlight that modest rate hikes cannot be taken for granted following every Board meeting, we do not think that December should be counted out.
Note that there will be a pause in January with no Board meeting scheduled, and rates are still a long way from the Bank's assessment of neutral. The consistent assessment that growth is likely to return to trend in 2010, with the clear implication that following this extended period of below normal interest rates growth will accelerate from that point, implies the medium term risks for the Bank are substantial. Central banks are obliged to focus on the medium term and it could be argued that the long pauses which we saw in 2002 and 2003 created the imbalances that eventually led to the Bank needing to tighten aggressively while the global crisis was developing.
Markets seem to be uncertain about the outcome of the December Board meeting and have interpreted these minutes as indicating that the Bank wants to emphasise its option to pause. We think the economics of the current situation will justify another move and the data developments since this meeting support that view.
Our view that the data since the Board meeting has been supportive of a continuously improving growth outlook was supported by the latest Westpac–MI Leading Index. The six month annualised growth rate of the Index jumped to 5.8 per cent. The increase in the growth rate over the last six months has been the sharpest increase since the economy bounced out of recession in 1975.
Westpac is forecasting economic growth to accelerate from 2 per cent in 2009 to near 4 per cent in 2010. That is a solid growth increase but not, as might be implied by the Leading Index, a boom period. The growth forecast contrasts with the RBA’s growth forecast of 3.25 per cent in 2010. We expect that the Bank is likely to further raise its growth forecast when it releases its next Statement on Monetary Policy on February 5. The gradual move towards a more normal interest rate setting over the course of the next few months is consistent even with the Bank’s current growth forecast which is around trend – monetary policy settings should not be well below neutral if growth is expected to return to trend.
Westpac’s second data release this week supports our view that growth will be solid rather than booming. As part of our Consumer Sentiment survey we asked respondents whether they planned to increase their spending on Christmas gifts this year. Surprisingly we found that around 15 per cent expected to increase spending while 35 per cent were looking to cut spending. Since this is the first time we have asked this question we cannot be sure whether there is a bias towards ALWAYS planning to cut spending at Christmas time.
Our best conclusion is that, consistent with some other work we have done recently on Consumer Sentiment, households will be more cautious in 2010 than usually implied by the current lofty levels of the Consumer Sentiment Index.
Bill Evans is chief economist at Westpac.