RBA announces interest rate remains unchanged

The Reserve Bank of Australia (RBA) has announced today that the Official Cash Rate will remain unchanged. Therefore the Official Cash Rate remains at 3.75%

The message today is that although rates are going up it will be gradual and measured. With the economy heading back to potential growth rates and little spare capacity, we see a ‘neutral’ policy setting as most likely by the second half of the year. Our estimate is that this involves a RBA cash rate of around 4.5% to 5.0%. We expect a 25bp rate increase next month unless global market weakness intensifies or the domestic data reveals a serious loss of momentum in early 2010.

The Statement released at 2.30pm notes that interest rates will need to rise over time if the economy plays out as expected. The reason for not moving today is stated as a desire to see more information about how the economy has been impacted by the previous three rate hikes (and noting additional increases by lenders after the December move). This was captured in the last paragraph of the statement “Since information about the early impact of those changes is still limited, the Board judged it appropriate to hold a steady setting of monetary policy for the time being.”

This was a position that the RBA took in early December after the last rate hike but which most economists and the market thought was likely to be revised given the surprisingly strong data (confidence, retail and employment) released over the past six weeks.

The RBA went further to say that improvement in economic conditions has been uneven. The RBA has confidence that households are doing well due to  “…strong labour market outcomes and a recovery in net worth.” However, the RBA remains more cautious on businesses  who continue to deliberate and, smaller businesses especially, to face tighter credit conditions. At the moment the RBA remain confident that inflation will get into the target band but note that “… inflation has risen somewhat recently as temporary factors that had been holding it down are now abating.” To us this is a key risk going forward.

In general, there is nothing in the statement which suggests that informal enquiries into the economy are revealing a sudden loss of growth momentum in early 2010, although we cannot rule this out as a factor. Both the ANZ Job Ads and the NAB business confidence index released this week were relatively soft. Overall we remain of the view that rates will rise gradually (target cash rate of 4.75% by end 2010). We do not think today’s decision rules out a move in March.

The caution associated with the path of further rate hikes in 2010 is due to several factors: the increased margin between official and lending rates due to the financial crisis; the higher indebtedness of households; the need to assess the impact of materially tighter policy; and  the fledgling nature of the domestic recovery and the fragile nature of the global one. Further, the nature of a neutral rate the is the RBA’s first aim in this tightening cycle is an increasingly uncertain concept, with the likelihood the RBA will know the level of the neutral rate once it gets there rather than before. This suggests to us the RBA will be increasingly careful on the pace of hikes as they move higher.

To us the risk to this view is clearly inflation and the fact that core inflation has persisted through the downturn and remains uncomfortably high, still outside the upper band of the RBA’s target. In November’s RBA Statement of Monetary Policy it forecast economic growth near or at trend at 3.25 in the December quarter we have no real quarrel with that given the strength of recent data. But given the persistence of core inflation when the economy was weak a trend rate of growth is arguably not the best environment to keep the downward momentum in inflation going. The November SoMP had a forecast of 3.25% for inflation in the year to the December quarter but this came in at 3.4%. In the current economic environment the RBA’s forecast of 2.25% for core inflation now seems ambitious. The output gap is closing, labour market pressures are emerging risking wage rise and there is seemingly limited further upside to the Australian dollar to keep imported inflation low. We expect the RBA to raise its forecasts for inflation in February’s SoMP released on Friday – but as inflation forecasts are lifted closer to the top end of the band the less margin for error the Bank has and the more they may have to do on rates in the short term.

Source RBA & ANZ



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