From Bill Evans of Westpac late yesterday:
As expected the Reserve Bank Board decided to leave the cash rate unchanged at 2.5%.
The two consistent themes of recent statements were retained: “the most prudent course is likely to be a period of stability of interest rates”; and “the Australian dollar remains above most estimates of its fundamental value”.
Commentary around the domestic economy was largely the same as we saw in the Governor’s November statement.
However there were notable changes around the exchange rate. Firstly and most importantly the Governor added a new sentence to the December missive, “A lower exchange rate is likely to be needed to achieve balanced growth in the economy”. Secondly he added “differences in monetary policy across the large jurisdictions are affecting markets, particularly exchange rates”. And finally, commodity prices are described as having “declined significantly in recent months”.
There was some speculation that recent falls in the AUD would have sufficed the RBA. However, recall that in November last year the Governor indicated that USD0.85 would be a fair value for the AUD at a time when the iron ore price was around USD135/tonne. With the iron ore price now around USD70/tonne clearly the Governor would like a significantly lower AUD than today’s USD0.85. No target value has been indicated by the Bank.
Concerns around differences in monetary policies would largely be targeted at the recent lift in quantitative easing from the Bank of Japan and signals that the ECB is planning a similar strategy. As the Bank consistently argued at the time of the Fed’s QE these policies of excessive liquidity creation by central banks often attracted flows into high interest rate currencies and were largely responsible for the AUD remaining overvalued in recent years.
As discussed on the domestic front the familiar themes were repeated: mining investment declining significantly; growth a little below trend for the next several quarters; spare capacity in the labour market and some time before unemployment declines; further pick-up in lending to investors in housing assets; and inflation consistent with the target.
The only additional nuance in the domestic discussion was around “the unemployment rate has edged higher” and “confirmed subdued rises in labour costs” – both points implying increased confidence around the inflation outlook.
The Bank appears to be relatively comfortable with the outlook for China’s growth by pointing out that government policies are now responding in a way that should support growth. This would be in response to the recent interest rate cuts and implies that the Bank is expecting more action around policy in China.
Conclusion
This statement is still consistent with rates remaining on hold for an extended period. The Bank appears to once again favour jawboning to try to lower the AUD but remains concerned about global capital delaying that adjustment. Markets were speculating that the Bank may decide to cut rates at today’s meeting. Such tactics would be most inconsistent with the patient approach that the RBA usually demonstrates; particularly given that there will be two months before the next meeting and much will be revealed about underlying momentum in the domestic economy and developments in commodity and exchange rate markets.
We are comfortable with our call that the next move in rates will be up particularly supported by a stronger outlook for the world economy where the US and China will be taking the lead.
China? I don’t think so, Bill. China is going to bump around a slowing trend next year. The US looks better, especially as oil falls, until it falls too far for shale. Bill is still calling for iron ore far north of $100 and the Aussie above 90 cents next year. The former is more likely to be $50 in 12 months and the latter materially sub-$80 as rates are cut.
In 2011, Bill Evans beat the market to rate cuts because most forecasters were focused on the RBA rather than on the economy. Now it is he that is making that mistake.
