Finally, the Reserve Bank keeps rates steady

Reserve Bank Board meeting

  • For the first time in four months the Reserve Bank has elected to leave interest rate settings on hold. The cash rate remains at 4.50 per cent.
  • It is what left unsaid that stands out in the Reserve Bank’s statement. The statement is surprisingly short and makes no reference to housing prices, consumer spending or the job market. The Reserve Bank Board says that monetary policy settings are “appropriate for the near term”, pointing to an extended stay on the interest rate sidelines.

What does it all mean?

  • You can almost hear the collective sigh of relief across Australia. Over 2008 and 2009 Aussie consumers and businesses had to contend with the North Atlantic financial crisis. And as soon as it finished then the Reserve Bank embarked on rapid fire rate increases. The only time that most people have been able to draw breath was at the start of the year. Now there is a second opportunity for Aussies to take stock
  • Aussie consumers and businesses are understandably shell-shocked and now need a little time to adjust to the new financial environment. So the hope is that this time around the pause in rates last longer than one month.
  • The Reserve Bank has no doubt been surprised at the extent of caution exercised by consumers. Surveys have regularly suggested that confidence levels are high, but the evidence at cash registers shows that people aren’t putting the money where their mouth is. Still, when faced with an aggressive Reserve Bank, it’s clear that the caution is justified.
  • Interestingly economists have a cash rate of around 5.00-5.25 per cent priced in by end year but financial markets are less sure, tipping rates won’t move over the next six months. As always it will depend on how inflationary pressures track over the remainder of 2010. But given that retailers are actively discounting rather than putting prices up, inflation doesn’t appear set to soar any time soon.
  • CommSec believes that the economy will lift later in the year, meaning borrowers should factor in rate increases of up to half a percent. But in the current environment this appears more of an upside risk. As we have seen over the past two months, the environment can effectively turn on a dime. The optimism that was in abundance in mid April has now given way to fear and uncertainty with investment markets increasingly skittish.
  • The shift in views in recent months is clearly in evidence in the bond market with yields on three-year government paper falling around 75 basis points (or three-quarters of a percent) in just the past month.

Interest rate decision and past cycles

  • • The Reserve Bank Board has left interest rates on hold for the first time in four months, leaving the cash rate at 4.50 per cent. In October 2009 cash rates stood at a 49-year low of 3.00 per cent. But then the RBA embarked on a process to remove the emergency stimulus, lifting the cash rate by a quarter of a percent in October, November and December 2009, and then in March, April and May 2010.
  • In the last rate-cutting cycle the cash rate fell to lows of 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent. 
  • But given that banks have been forced to lift rates above the cash rate, the Reserve Bank has looked more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.40 per cent, above the long-term average or “normal” rate of 7.15 per cent.
  • The Reserve Bank says: “Taking all the available information into account, the Board views this setting of monetary policy as appropriate for the near term.”
    What are the implications of today’s decision?
  • The $64 million question is how long will interest rate settings remain on hold? Clearly consumers and businesses would love some assurances. Unfortunately that’s not possible – even the Reserve Bank would be hard-pressed making sense of the volatile environment. But certainly people need some sense of the interest rate trajectory so that they can plan and generally get on with business.
  • The six-month overnight indexed swap rate is as good as any indicator in providing views on the interest rate outlook. And at present the pricing points to no change in cash rates until much later in the year.
  • Housing and retail-focussed businesses have most to celebrate in today’s ‘on hold’ decision by the Reserve Bank – especially retailers of discretionary, non-essential or luxury goods.
  • Looking ahead, it is clear that the Reserve Bank has sole responsibility for keeping the economy on the straight and narrow. The Federal Budget confirmed that fiscal policy isn’t playing an active role at present with the ‘automatic stabilisers’ relied upon to improve the budget bottom line as opposed to discretionary spending cuts or tax increases by the Government. So if the economy picks up pace, the focus will again switch to rate hikes.
  • The modest size of the accompanying statement from the Reserve Bank almost suggests that Board members had to leave the meeting in a hurry. We are now effectively in the dark about its views on the economy given that most of the statement focussed on Europe, not Australia.

Comparing the two most recent statements

  • The statement from the May meeting is below; the statement from this weeks June 2010 meeting is below that.

MEDIA RELEASE
No: 2010-07
Date: 4 May 2010
Embargo: For Immediate Release 
STATEMENT BY GLENN STEVENS, GOVERNOR
MONETARY POLICY

At its meeting today, the Board decided to raise the cash rate by 25 basis points to 4.5 per cent, effective 5 May 2010.

Recently, forecasts for world GDP growth have been revised up again, and growth is expected to be at trend pace or a little above in 2010. Conditions in Europe remain quite weak, though recent data suggest growth is becoming more established in North America. In Asia, where financial sectors are not impaired, growth has continued to be strong, contributing to pressure on prices for raw materials. The authorities in several countries outside the major industrial economies have now started to reduce the degree of stimulus to their economies.

Global financial markets are functioning much better than they were a year ago, but sovereign risk concerns have escalated significantly in Europe over recent weeks. This has prompted additional efforts by policymakers to put fiscal policies onto a sounder footing and to provide support for Greece in the near term. To date, there has been very little contagion outside Europe. 

Australia’s terms of trade are rising by more than earlier expected, and this year will probably regain the peak seen in 2008. This will add to incomes and foster a build-up in investment in the resources sector. Under these conditions, output growth over the year ahead is likely to exceed that seen last year, even though the effects of earlier expansionary policy measures will be diminishing. The process of business sector deleveraging is moderating, with business credit stabilising and indications that lenders are starting to become more willing to lend to some borrowers, though credit conditions for some sectors remain difficult.

Credit outstanding for housing has been expanding at a solid pace. New loan approvals for housing have moderated over recent months as interest rates have risen and the impact of large grants to first-home buyers has tailed off. Nonetheless, at this point the market for established dwellings is still characterised by considerable buoyancy, with prices continuing to increase over recent months.

Recent data on inflation confirm that it has declined from its peak in 2008, helped by a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand. In both underlying and CPI terms, inflation over the most recent 12 months was around 3 per cent. Nonetheless, the extent of decline from here may not be quite as much as earlier forecast and inflation now appears likely to be in the upper half of the target zone over the coming year. 

With the risk of serious economic contraction in Australia having passed some time ago, the Board has been adjusting the cash rate towards levels that would be consistent with interest rates to borrowers being close to the average experience over the past decade or more. The Board expects that, as a result of today’s decision, rates for most borrowers will be around average levels. This represents a significant adjustment from the very expansionary settings reached a year ago. 

The Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of 2–3 per cent over time.

MEDIA RELEASE
No: 2010-11
Date: 1 June 2010
Embargo: For Immediate Release 
STATEMENT BY GLENN STEVENS, GOVERNOR
MONETARY POLICY

At its meeting today, the Board decided to leave the cash rate unchanged at 4.5 per cent.

Since the Board last met, concerns about sovereign creditworthiness in several European countries have been a focus of financial markets. Investors have generally displayed a good deal more caution. As a result, equity prices have fallen and long-term government bond rates have declined outside of the countries most affected by the sovereign concerns. The Australian dollar fell sharply as part of this adjustment. Commodity prices have also softened, though those important for Australia remain at very high levels. European policymakers have responded by assembling a large package to provide financing for the relevant countries for a period of time, stabilise bond markets and provide liquidity. They have also committed to action to bring budget deficits down and stabilise debt over time. 

The effects of these various factors on the world economy will need to remain under review. At this stage, global growth is still expected to be at about trend pace in 2010. Conditions in Europe overall have been relatively weak, and the foreshadowed budgetary tightening will probably mean that this will continue, but growth is becoming more established in North America. In Asia, growth has continued to be quite strong and may need to moderate in the year ahead. In Australia, with the high level of the terms of trade expected to add to incomes and demand, output growth over the year ahead is likely to be about trend, even though the effects of earlier expansionary policy measures will be diminishing. Inflation appears likely to be in the upper half of the target zone over the next year. 

Consistent with that outlook, and as a result of actions at previous meetings, interest rates to borrowers are around their average levels of the past decade, which is a significant adjustment from the very expansionary settings reached a year ago. Taking all the available information into account, the Board views this setting of monetary policy as appropriate for the near term.

Source Craig James, Chief Economist, CommSec