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RBA stresses no timetable for rate hikes

Reserve Bank Board meeting

  • At the last Reserve Bank Board meeting, members agreed that "conditions in the global and Australian economies were significantly better than had been expected earlier in the year" and "the growth outlook for the next few years had improved".

  • Board members concluded that it remained prudent to gradually reduce the amount of stimulus being provided by monetary policy. Importantly the minutes highlighted that board members are not locked into a set timetable on rate hikes, rather it will be dependent on the most recent round of data.

  • CommSec believes that rates will rise by 25 basis points at the December meeting, before the Reserve Bank retires to the sidelines until the February meeting.

What does it all mean?

  • The Reserve Bank hasn't changed the tone or the language in the most recent statement. The Reserve Bank believes that the Australian economy is likely to return to "trend growth" in 2010, while inflationary risks, so far, remain well contained. It is quite clear that the expansionary interest rate setting will be reduced over time given the improving economic conditions.

  • If anything the latest Reserve Bank Board minutes further highlighted the significant improvement that has taken place in not just the domestic economy but also on a global front. Board members were clearly optimistic on the global economy sighting the turnaround in the US housing sector and in particular the strong recovery in our Asian counterparts, China, India and Korea.

  • The Board is clearly mindful that the higher Australian dollar will restrain inflation but at the same time constrain parts of the economy. Sectors like tourism, manufacturing, and rural exports will continue to be less competitive as the Australian dollar continues its ascendency towards parity.

  • The Board highlighted that the Australian economy had less spare capacity than previously anticipated. And it is likely that tighter capacity will be an issue that is fleshed out in more detail in coming months. The Reserve Bank is clearly attempting to ensure that additional capacity is put in place to ensure that inflationary pressures are curtailed in the midterm.

  • Overall there is nothing in the statement to change our view that the Reserve Bank will raise interest rates for an unprecedented third consecutive month in December. In fact the economic data over the last month has reinforced our conviction about the December rate call. Business conditions, consumer confidence, lending aggregates and labour market conditions have all recorded healthy readings. And next week's business investment data is the only unknown that could influence the Reserve Banks December meeting.

What do the figures show?

Minutes from the November Reserve Bank Board meeting
Key Comments:

  • Retail spending: "Staff liaison had pointed to retailers experiencing mixed conditions in September and October, although the broader perspective was that spending appeared to have held up reasonably well given that the earlier boost from the payments to households was fading."

  • Economic outlook: "Overall, members considered that the recent information was consistent with the conclusions reached by the Board a month earlier: namely, conditions in the global and Australian economies were significantly better than had been expected earlier in the year when the Board had lowered the cash rate to 3 per cent; the Australian economy was operating with less spare capacity than earlier thought likely; and the growth outlook for the next few years had improved. The Board therefore concluded that it remained prudent, over time, gradually to reduce the degree of monetary accommodation."

  • Future rate moves: "Looking ahead, members expected that if economic conditions evolved as expected, further gradual adjustment in the cash rate would most likely be appropriate over time, though the pace of the adjustment remained an open question."

  • Timing of rate moves: "In considering the pace of that adjustment, members were conscious of balancing risks. On the one hand, business and consumer confidence could prove fragile, and economic activity at home and abroad might slow more than expected as the effects of stimulus measures faded. Also, the rise in the exchange rate would constrain output and dampen inflationary pressure, and credit conditions for some borrowers remained quite difficult. On the other hand, a lengthy period with interest rates at a very low level carried its own risks, particularly once the threat of serious economic weakness had passed."

  • Business funding: "Many larger firms appeared to have replaced bank credit with debt and equity financing in the capital markets. As a result, the overall external funding to the business sector was still growing."

  • Supply issues: "Members noted the weak outlook for construction of apartments, in contrast to the current strong population growth. Among the possible causes discussed were the roles played by tighter lending standards on the part of banks and the costs of new development from the zoning and approvals processes. With both the population and the capital stock growing at rates that were high by both historical and international standards, the medium-term production capacity of the economy was expanding, though measured growth in productivity had been weak in recent years."

  • Bank funding costs: "Strong competition for deposits, partly reflecting a desire by banks to reduce their reliance on short-term capital market funding, had pushed up interest rates on deposits relative to other funding sources. Members considered the possible implications for Australian banks of global proposals for changes to liquidity and capital standards."

What is the importance of the economic data?

  • The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.

What are the implications for interest rates and investors?

  • It is clearly important to realise that the Reserve Bank is not tightening monetary policy in an attempt to curtail growth, rather it is winding back stimulus. As the economy continues to strength the stimulus tap needs to be turned off. The cash rate will need to get close to around five per cent before the stimulatory effect is put to rest.

  • Certainly the relatively high underlying measures of inflation, coupled with the stronger level of domestic economic activity will be a key concern going forward, and the likely barometer for the timing of rate hikes.

  • At this stage the Reserve Bank looks likely to raise rates in December by 25 basis points, before taking a well earned break over Christmas.

Source Savanth Sebastian, Economist, CommSec