From Bill Evans at Westpac:
As expected the Reserve Bank Board decided to leave the cash rate unchanged at 2.50%.
In addition the Bank has abandoned its ‘soft’ easing bias and adopted a clear neutral bias. That is evidenced by the final sentence in the Governor’s statement: “On present indications, the most prudent course is likely to be a period of stability in interest rates”.
The other major development in this statement is the discussion around the Australian dollar. At the December meeting the AUD stood at around USD 0.91 and by today’s meeting it had fallen to US 0.875. This fall appears to have placated the Governor since unlike in December when the AUD was described as “uncomfortably high” there is no reference to the level of the currency in this statement. In fact he has reverted back to assessing that if the current decline in the currency is sustained the desired rebalancing of the economy will be ably assisted. The motive behind desisting from further talking down of the currency may be partially due to the lift in tradeable inflation in the December quarter, which was responsible for the surprise 0.9% print of underlying inflation when market expectations were around 0.5%.The Bank runs the risk that markets will interpret this new approach as indicating that the Governor is now satisfied that the exchange rate has reached an acceptable level due to the inflation constraint.
The Bank is also mindful that the decline in wages is likely to lead to some moderation in the growth of non-traded inflation. It is likely that this scenario will be incorporated into future inflation forecasts allowing the Bank to anticipate a marked offset of the currency effect through softer wages. We concur with this view.
Commentary around the real economy highlights the diverse developments which are now becoming apparent. Whereas housing construction is described as “in a solid expansion” business investment prospects continue to be described as “subdued.” The labour market “has remained weak” and “growth in wages has declined noticeably”.
The Bank is clearly careful to emphasise that there is no case for higher rates. Indeed the outlook continues to be for below trend growth and rising unemployment. There is also a degree of confidence around the inflation outlook with inflation still expected to be consistent with the 2 to 3% target over the next two years. In this regard the inflation forecasts which will be released with the February Statement on Monetary Policy on February 7 will be very important. We certainly expect that annual inflation to the June quarter will be revised up from 2.5% to 2.75% – consistent with “Inflation is expected to be somewhat higher than forecast three months ago”
However the much more important forecast will be underlying inflation for the 2014 calendar year. To ensure that debt markets do not overreact I expect that the 2-3% range will be retained for that forecast rather than a more disturbing forecast of 2.5-3%. Certainly underlying inflation for 2015 will continue to be forecast at 2-3%.
The commentary on the world economy is less positive than previous statements. In particular, the China outlook is, somewhat vaguely, described as “in line with policymakers’ objectives” while emerging markets are mentioned for the first time as facing “considerably more challenging conditions than they were a year ago”.
Conclusion
Westpac has been anticipating an extended period of steady rates. This scenario is now confirmed in the Governor’s statement. Markets which are usually uncomfortable pricing in no rate moves are likely to focus on rate hikes rather than our own view that rate cuts are more likely. Many of the arguments supporting eventual cuts are woven into the Governor’s statement: rising unemployment; subdued business investment; below trend growth; slowing wages; some disturbing signals in the world economy particularly around emerging markets, and, to an extent, China; stability in the Australian dollar and moderating inflation as the one-off effect of the lower currency does spark secondary price impulses containing inflation pressures.
We do not expect rates to be lowered before the second half of 2014 when many of the apparent puzzles in today’s statement will be resolved.Our current view is for a move in August to be followed up with a further move later in the year.
