From Westpac’s Bill Evans today:
As expected the Reserve Bank Board decided to hold the cash rate steady at 2.50% in December. The Governor’s statement was virtually identical to the November statement with only five words being changed. The first change related to the assessment of the inflation outlook where wages were added to prices as pointing to contained inflation pressures. We think that the soft wage outcome (2.5%yr) for the September quarter was particularly welcome to the Reserve Bank indicating that non-tradable inflation pressures are likely to ease from this point. The other change related to housing and equity markets being described in the previous statement as having “strengthened further” to now being quoted as having “strengthened further over recent months”. It is not clear whether these additional words have any real significance.
Conclusion
Since the November Board meeting a number of developments have been particularly significant. Firstly the Bank lowered its growth forecast for 2014 from 3% (trend) to 2.5% (below trend). However it retained the view that growth in 2015 would lift to 2.75%-4.25%. While the buoyant although (given the wide confidence band) imprecise forecast for 2015 has been retained it is reasonable to assert that a central bank which is predicting below trend growth one year out and remains confident about containing inflation should be providing more stimulus to the economy. The Governor’s speech on November 21 which referred to the possibility of currency intervention, complements the consistent language in this statement and the November statement around the currency. The sentiment that the Australian dollar remains uncomfortably high and a lower currency would assist in rebalancing growth indicates a clear preference for a lower currency. It appears that the additional stimulus is planned to come through a lower currency rather than the conventional channel of lower interest rates.
Over the course of the next few months there will be a range of major developments that will determine whether this strategy is successful. Most importantly the policy actions by the US Federal Reserve will be critical. It appears that financial markets are warming to the prospect the Federal Reserve implementing a tapering strategy for its quantitative easing program in the near term. While arguably that action is already priced in to financial markets it is likely to further assist the Bank’s objective of lowering the AUD. It is our view that tapering is not likely until 2015 and as such the Australian dollar is likely to drift upwards. In those circumstances and with the expected ongoing need for further stimulus it seems reasonable that the Bank will eventually choose the more conventional method which will involve lower rates.
The timing of those policy actions will also be determined by developments in the housing market since the key motive for eschewing rate cuts appears to be concern over a housing bubble. However the case for stimulus is likely to become more urgent as the Australian labour market continues to weaken and the unemployment rate rises more rapidly than we have seen in recent months. For now our forecast is that these developments may occur as soon as the March quarter with February nominated as the starting date. However, given the range of uncertainties around the current situation this timing could easily be delayed. We will continue to monitor currency, housing and labour markets in particular over the next few months but our central forecast is that eventually the need for further stimulus will be satisfied by the more conventional channel of lower interest rates.
