There were two surprises in yesterdays RBA decision statement. The first has been well examined, that it dropped any reference to the need for a lower Australian dollar implying to markets that it’s happy with the current elevated value. The result was obvious with the dollar soaring through 89 cents last night. The bank seems to have underestimated the efficacy of its own jawboning.
The other surprise was the conclusion:
In the Board’s judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.
This is really what got the dollar going. The RBA removed any imminent threat of future rate cuts. Why would it do so given it clearly does not want the dollar to rise?
This kind of strong forward guidance is reminiscent of the Fed’s innovations over the past few years in which it has formally adopted targets for its rates triggers as a way to manage market interest rates (for instance to prevent US long bonds blowing out as it tapers).
While the RBA’s guidance is much less formal than that of the Fed, it is very unusual for the RBA to adopt such longer term suasion at all. It is generally very dedicated to the data flow and hence has been able to move rates swiftly and often against its own economic forecasts, and quite rightly so.
So why now? Especially since jawboning was working so well?
I reckon the answer is threefold. The first is the simple face value that the RBA is confused, just as the economy is currently confusing. The statement yesterday was very uncertain about the timing of the major cross-currents that constitute the Australian “rebalancing”. There is a lot of economic change underway, a new government as well, so the bank may see some stability in rates as a useful way to anchor activity.
The second reason is that the RBA does not want market economists getting ahead of it on calling the turn in the rates cycle. It knows that the “rebalancing” project is structural and far from complete but the cyclically-focused economists that dominate the market like to ignore the structural forces so a period of stable, if accomodative, rates prevents any breakout in rate rise expectations.
Third, and perhaps even more important, the RBA noted the following:
Inflation in the December quarter was higher than expected. This may be explained in part by faster than anticipated pass-through of the lower exchange rate, though domestic prices also continued to rise at a solid pace, despite slower growth in labour costs. If domestic costs remain contained, some moderation in the growth of prices for non-traded goods could be expected over time.
That can be read as a statement that the bank will “look through” tradable inflation. It’s a long way short of the kind of explanation of a real exchange rate adjustment I recommended yesterday, but it is the functional equivalent of just that. In effect the bank is telling the market that it can ignore tradable inflation because future disinflation will bring it into line and reinforcing that message with a commitment to not move rates upwards.
The price for the policy shift has so far been a tearaway dollar. But, over time, if the RBA’s message is reinforced, it should fall back, especially in a context of an ongoing China and emerging markets slowdown. More of challenge will arise if that brings the Fed’s taper to a sudden halt.
