What the bank really thinks...
I nterest rates aren't like elevators. They don't only rise and fall, they can go sideways, too, and on Tuesday the Reserve Bank decided it had room to do the sideways shuffle.
Here's the heart of the analysis it issued with its announcement that the cash rate is being left at 3 per cent, with my comments interwoven.
"Inflation is consistent with the medium-term target [at] around 2 per cent on the latest reading ... with the labour market softening somewhat and unemployment edging higher, conditions are working to contain pressure on labour costs. Moreover, businesses are likely to be focusing on lifting efficiency under conditions of moderate demand growth. These trends should help to keep inflation low, even as the effects on prices of the earlier exchange rate appreciation wane. The bank's assessment remains that inflation will be consistent with the target over the next one to two years."
Translation: Inflation is actually sitting at the low end of our target of 2 to 3 per cent, so there's no barrier to us cutting the cash rate further when we want to - and the forces that are keeping inflation down include some that are keeping rate cuts on the agenda, including weakness in the jobs market, one of our core areas of concern.
"During 2012, there was a significant easing in monetary policy ... the full impact of this will still take further time to become apparent [but] there are signs that the easier conditions are having some of the expected effects: demand for some categories of consumer durables has picked up; housing prices have moved higher; there are early indications of a pick-up in dwelling construction; and savers are starting to shift portfolios towards assets offering higher expected returns."
Translation: We cut rates four times between May and December last year, pulling the cash rate down from 4.25 per cent to 3 per cent. That's a hefty reduction, and there are clear signs it is working. Consumers are spending more and investing differently - in the sharemarket for example, where dividend yields beat fixed interest. We still don't believe, however, that the full impact of last year's cuts has been felt.
"On the other hand, the exchange rate remains higher than might have been expected, given the observed decline in export prices, and the demand for credit is low, as some households and firms continue to seek lower debt levels."
Translation: There are also head-winds, and at around $US1.04, the Australian dollar is the big one. It is making our exports less price competitive at a time when domestic demand is soft, and it has made imports cheaper in $A terms, creating a double-whammy for local companies. The currency is, however, high mainly because rates in the developed economies overseas are at or close to zero. Foreign money has been pouring in to capture our still relatively high fixed interest rates, and to hide from northern hemisphere economic carnage. Another quarter of a percentage point cut in the cash rate won't change that dynamic materially.
We've considered intervening Switzerland-style to push the $A lower, but the cost is prohibitive. Short of the government killing two birds with one stone by raising revenue with an impost on capital inflows, the $A is going to stay high until either the northern hemisphere begins growing strongly again, pushing rates there higher, or, in a cure that is worse than the disease, until the next global recession hammers commodity prices and Australia's resources economy.
"The board's view is that with inflation likely to be consistent with the target, and with growth likely to be a little below trend over the coming year, an accommodative stance of monetary policy is appropriate. The inflation outlook ... would afford scope to ease policy further, should that be necessary to support demand ..."
Translation: The current rate of 3 per cent is close to the low but we have room to cut a bit more, and may do so.
"The board ... will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the target over time."
Translation: Much depends on economic recovery in the United States, Europe and China continuing, and in this economy, the signals are still mixed.
As we met on Tuesday we learnt, for example, that Australia's trade deficit had narrowed to $427 million in December from $2.8 billion in November and an average of $2.1 billion in the five months to November, as China rebuilt iron ore stocks, and as heavy machinery imports slowed.
That's a double-edge sword: the miners boosted export revenue by selling more iron ore in December, and in January and February their revenue and Australia's export income should jump again as higher spot market prices feed in. The reduction in heavy machinery imports flows, on the other hand, from a more general slowdown in resources sector project development that began last year as the boom cooled - and with the dollar staying high, the non-resources sectors are not filling the gap.
We may need to go lower, in summary - but the new year has started fairly positively, here and overseas, in both the real economy and the markets. That gives us time to watch and listen, and we are going to use it: it's not procrastination - its precaution.