RBA musings

A couple of the banks have put put out commentaries on the RBA Minutes that are of interest. First up, Paul Bloxham of HSBC:

Minutes show they were on the verge of hiking
The minutes were mostly old news. But they do remind us just how close the RBA was to hiking, due to inflation concerns. If not for ‘acute uncertainty in global financial markets’ they would have! This mounts a huge hurdle for the RBA to even consider a cut, as markets are currently pricing. We think this hurdle is too high given global developments to date and that the RBA will hold in September. Looking further forward, we still think rising inflation will mean the next move is up, though the risk is clearly for a longer pause. Much depends on global financial market developments in coming weeks.

– ‘There was considerable uncertainty about … how fiscal problems in Europe and the United States would be resolved … and what effect the ongoing market volatility would have on the global economy. At the same time, commodity prices were remaining high and this was feeding through into higher rates of global inflation.’
– ‘Domestically, there were significant divergences between sectors. Activity in parts of the economy was subdued, with consumers remaining cautious and business confidence having fallen somewhat … the boom in the resources sector was benefiting some other sectors … surveys suggested that business conditions, in aggregate, were around the average level of the past two decades and that the unemployment rate was at a low level.’
– ‘The recent inflation data had been higher than expected. Members believed there were grounds for concern about the medium-term outlook for inflation, given the relatively limited spare capacity in the economy, the widespread increase in cost pressures, including in imported goods, and the relatively low rate of productivity improvement.’
– ‘The argument for tightening further was that underlying inflation had started to pick up and the central projection in the staff forecasts envisaged it rising above the target range during the forecast period.’
– ‘The case against tightening at this meeting was that the downside risks to demand had probably increased, as a result of the acute uncertainty in global financial markets over the recent period. If the financial market turmoil continued, it could further weaken household and business confidence. This in turn could weaken the outlook for demand relative to the central forecast and, over the medium term, dampen the inflation outlook.’
– ‘Members noted that … financial conditions were already exerting a reasonable degree of restraint.’

Implications
Today’s minutes are largely old news, although it is worth keeping in mind that they can be edited right up until they are published, so retrospect may affect the tone.

Vindicated, would be an apt adjective to describe the RBA’s current position. As we had suggested prior to the meeting, while the central forecasts for inflation called for a rate rise, the risks around those forecasts were much larger than normal. The policy of ‘least regret’ was to hold rates steady due to the risks, and that is what they did. The minutes also show that it was a very close call. They were on the verge of hiking and if not for ‘acute uncertainty in global financial markets’ they would have!

Keep in mind that the meeting took place before the US debt ceiling had been lifted and many of the other recent financial market developments were just tail risks in the twinkle of the eye of an RBA forecaster.

Since then, financial markets have shown some extraordinary volatility, largely on the back of uncertainty about the capacity and willingness of policymakers in the US and Europe to work through problems. Deciphering what this means for the economy is very hard, especially as many of the uncertainties persist.

On the local economy, the RBA gave greater recognition to the growing divergences across the economy. They also flagged that if ‘the financial market turmoil continued’ – which we know it has – ‘it could further weaken household and business confidence’ and that this could ‘weaken the outlook for demand relative to the central forecast and, over the medium term, dampen the inflation outlook’. The narrative is building for a downward revision to the RBA’s inflation forecasts.

But we are not there yet. The latest set of inflation forecasts from the RBA suggested that inflation heads above the band in annual terms next quarter and stays above the target band for the next two years.

To motivate rate cuts the RBA would need to be confident that inflation was going to fall at least into and probably to the lower part of the target band. This is a huge hurdle. In our view, global financial developments to date are not enough to motivate that kind of revision.

So at this stage we do not think the RBA would be considering a cut as soon as September, nor giving much countenance to the 120bps of cuts priced in over the next year. This market pricing probably reflects the risk of a much larger negative global financial market event than has happened to date.

Bottom line
Much of the discussion and market pricing has turned to RBA rate cuts.

We still think the hurdle for rate cuts is huge, given the inflation outlook, and has yet to be met.

We still think there are upside risks to inflation which would suggest the next move is up, though the risk is clearly for a longer pause.

I’ve got no problem with a bit shameless self-promotion if you get a big call right. But this doesn’t feel right to me. As I said earlier today, the Minutes I read never seriously canvassed a rate rise. Rather, they were deeply concerned with risks, both international and domestic.

Anyway, if we look past the toasting to self, there is one useful point here. Significant roadblocks do still stand in the way of rate cuts. Certainly more significant than was suggested in yesterday’s widely publicised celebration of Bill Evans (which perhaps helps explain the Bloxham self promotion). I still think, at this stage, that Bill Evans will be proven right, but there’s not enough blood in the streets yet. Markets are significantly overpricing the chances of a September cut, unless we see further international deterioration in the intervening period.

As for Bloxham’s contention that the next move is most likely up, only if the QE3 rally takes hold against the odds and even then it would have to mainline inflation straight into Australia’s veins. And probably not even then. The employment market was turning before the recent market turmoil.

Next up is ANZ, who got the August call wrong but, ironically, deliver a much more balanced assessment of the Minutes:

The first point to note about today’s Minutes is that they pre-date the past two weeks of very volatile trading in Australian and global financial markets, which are likely to have a further negative impact on business and consumer confidence.

At the August Board meeting, the Board considered tightening monetary policy further as underlying inflation had begun to pick up and the Bank’s central forecast was that inflation would rise above the target band during the forecast period.

Two factors stopped the Bank tightening even with this central inflation forecast:

(1) the downside risks to demand growth had increased due to acute uncertainty in global financial markets (in turn due to European and US sovereign debt issues). Should this turmoil lead to even more subdued behaviour by consumers and households then demand growth could weaken relative to the forecast outlook, thereby dampening inflation pressures without the need for further policy action.

(2) separately, the Board considered that the behaviour of various economic indicators reflected that financial conditions (ie monetary policy plus the exchange rate and asset price developments) were already exerting a significant degree of restraint even though interest rates were only a little above average.

The second of these seems to represent quite a considerable evolution of the Board’s thinking, as the Bank had been quite confident that interest rates needed to rise over the medium term (earlier intimating that rates would need to increase by more than the two rate hikes priced into the curve). This has been an important part of recent arguments that rates may already be a bit tight for the performance of the non-mining sectors of the economy, even though the mining sector is picking up quite strongly (a point reiterated in the minutes).

The minutes contain two pieces of specific information about the Bank’s liaison programme on evolving conditions in the Australian economy:

(1) retail spending had been weak since mid May;

(2) the staff’s liaison with businesses indicated some caution in hiring plans.

What does this imply about the future course of interest rates relative to what is priced into the curve?

At the Board meeting in early August, the Bank thought it should tighten further for inflation reasons, but held off due to global concerns and signs that financial conditions were restraining growth already. Importantly credit and funding markets were functioning well. Since that time:

– global uncertainties have increased further, though equity markets and bank share prices have rebounded in recent days;
– domestic Australian economic indicators and anecdotes have remained on the soft/softening side, but with the exception of continuing very weak retail anecdotes have not shown signs of dramatic collapse as in the wake of Lehman’s failure; and
– credit and funding markets have shown some signs of increased pressure, albeit not to the same degree as post Lehmans.

Taken together, these impacts rule out the need to consider any further tightening in the near term and appear to open up the possibility of a modest easing cycle beginning later this year or early next year, if international conditions continue to deteriorate and Australian data and labour markets continue to soften. They do not appear to support an imminent or aggressive easing cycle as currently priced. The latter would seem to require further significant pressures emerging in global and Australian funding and equity markets (not that this can be totally ruled out in current very fluid markets). Similarly, a very early move except in exceptional circumstances would seem unlikely given the Bank’s concerns about inflation – in the first instance, allowing some further softening in demand would help bring the inflation track back on a more comfortable setting for the staff.

ANZ will review its interest rate forecasts after coming labour market data. So far, while job advertising trends have slowed modestly, they are not collapsing, another factor, arguing against the need for an aggressive easing cycle in the near term.

Sounding positively Evansesque they are. I pretty much agree.

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Comments

  1. ‘Evansesque’??? ‘RBA Minutes fascinating’???

    Have you had a lapotamy HnH…

    Evans only changed his turn when it was obvious to everyone but the Bullhawks that things were not going well and the RBA, due to the housing bubble his bank helped create was at risk of collapsing due to slower and slower credit growth.

    I think Keenesque would have been more fitting…

    http://www.debtdeflation.com/blogs/2011/08/01/high-noon-tuesday-at-the-rba/

    The man is a prophet!

  2. Fair enough HnH, probably a bit too soon to unveil a statue of Keen.

    Can you explain something for me…I dont understand what they mean when they say markets are betting on a rate rise. I know there are betting options (as in Centrebet etc… offer odds on interest rate decisions) but I presume these odds are based on some financial market?

    Also – how do they price these things…i.e. Is is % probability of rate rise Vs rates staying flat Vs rates dropping?

    Thanks mate