WEEKEND ECONOMIST: 'Scope' outs the RBA
With just one small word, the RBA has set the stage for an October, rather than November, rate cut. It would be a welcome move.
With the RBA delivering the first cut of 25 basis points on June 5 we expected to be in good shape for a further 75 basis points through to year’s end.
That was despite general criticism that the call was way too aggressive. In the event, the timing probably did turn out to be too aggressive in the wake of a first quarter GDP growth print of a stunning 1.3 per cent which was released on June 6.
While some were moved to scale back any interest rate cuts altogether we maintained the likely extent of the cuts at 75 basis points but reshaped the profile to 50 basis points in the December quarter to be followed by another 25 basis point cut in the first quarter of 2013.
The start date of the cuts was described as October/November with a second expected shortly thereafter. At the beginning of this month we fine tuned our timing to November as the start date mindful that since being appointed in July 2006 this governor has moved rates at every November board meeting. However, we pointed out that of the six moves four have been hikes and two have been cuts.
The CPI report tends to be more significant in a tightening cycle than in an easing cycle. There is less urgency to await the CPI when rates are being cut than when they are being increased. That makes the choice between October and November more complex than if the cycle was likely to be a tightening cycle.
Our snap first take on the minutes of the September board meeting indicated that the board was close to a rate cut but probably not sufficiently close to bring the first move forward to October.
In the analysis of the minutes I noted, "Today’s Minutes of the RBA’s September board meeting show some significant signals that the Reserve Bank is close to cutting rates ... the ground work has been laid for a move as soon as October...We assess that the bank is close to moving on rates but, in a close call, do not assess that there is sufficient evidence from these minutes to revise our view that the cuts are likely in November and December”.
With time to further analyse the minutes we believe the odds now slightly favour an October move rather than waiting until November.
The aspect of the minutes which merits most scrutiny is the statement, "the current assessment of the inflation outlook continued to provide scope to adjust policy in response to any significant deterioration in the outlook for growth”.
Use of the word "scope” is significant. That word rang a few bells with us. It has been used sparsely but significantly in the past during easing cycles.
Since August 2008 there have been two easing cycles – August 2008 to April 2009 and October 2011 – present. During those cycles there have been 20 board meetings – eight in the August – April period and 12 in the October – present period.
In the minutes the word "scope” has been used on six occasions in the key paragraphs on Considerations for Monetary Policy. Three coincided with the meeting where the decision had been made to cut. Consider "As such members saw scope for a modest reduction in the cash rate” (April 2009); "members felt that there was scope for a modest reduction in the cash rate” (December 2011). "Members considered there was scope for monetary policy to be a little more supportive” (June 2012).
Arguably, the use of the word at that time emphasises its appropriateness for an easing cycle.
Of much more interest is, "scope to move towards a less restrictive setting of monetary policy was judged to be increasing” (August 2008). Rates were cut at the September meeting.
"Members believed that an improved inflation outlook, if confirmed by further data, would increase the scope for monetary policy to provide some support to demand, should that prove necessary” (October 2011). Rates were cut in November.
Less encouraging is, "If demand conditions were to weaken materially, the inflation outlook would provide scope for a further easing in monetary policy” (February 2012). Of course there was no rate cut in March but that decision may have stemmed from the surprise Employment Report which printed five days before the release of the minutes showing employment growth of 46,300 jobs.
Equally, this February 2012 comment could be assessed as being more comparable to the recent statement because it included a hurdle condition – "demand conditions weaken materially” compared to the recent statement, "significant deterioration in the outlook”.
Certainly, the conditions in the August 2008 and October 2011 were less stringent.
However, I would argue that the recent condition is subjective, referring to the Outlook, rather than demand conditions. Many reasons could be raised to justify a deterioration in the outlook whereas "demand conditions” refer to a deterioration in the data print – a 46,300 employment report hardly qualified as "deterioration”.
Much of this analysis may be described as pedantic. And Westpac Economics certainly sees its primary contribution to assess the medium term outlook (in the most recent example we forecast 100 basis points of rate cuts back in June distributed over the course of the remainder of 2012).
However, some of our customers are interested in the specific month to month timing of these moves and hence the attempt to put some analysis behind reasons for choosing particular months.
Even in the near term, for us, there is more importance in our assessment that "back to back” moves will be necessary. If our call for October proves correct then a November move would be the next expected outcome.
Market pricing suggests that while markets are warming to the October scenario they "only” give around a 50 per cent probability to October/November. We expect that would change dramatically if the October move eventuates.
Bill Evans is Westpac's chief economist.