Fresh from our Bill:
The most significant change in the minutes of the April Board meeting is around a higher degree of concern about the Australian dollar. Whereas in the March minutes the Board noted that “the decline in the exchange rate seen to date would assist in achieving balanced growth in the economy” this sentiment is now modified with: “despite commodity prices falling further over the past month the exchange rate had appreciated a little further. While the decline in the exchange rate from its highs a year earlier would assist in achieving balanced growth in the economy this would be less so than previously expected given the rise in the exchange rate over the past few months”.
To put this in perspective the AUD had risen from USD 0.8950 at the March Board meeting to USD 0.9240 at the April meeting and a subsequent move to USD 0.9390 today.
Using the preferred month average approach followed by the Reserve Bank, note that the low point in this cycle in the TWI was around late January with a 15% fall; by March it had shrunk to a 12% fall and as at today it is a 9% fall.
Of most interest is the Bank’s observation that commodity prices have moved in the opposite direction. This of course means financial conditions are seen to have tightened.
In fact recall that at the December Board meeting when the AUD was around USD 0.91 the Board referred to the AUD as “uncomfortably high” and noted that there was scope for lower rates.
In today’s minutes and in keeping with the March minutes the currency is only described as “high by historical standards”. The question must be asked as to whether the Board might revert back to at least using the “uncomfortably high” description for the AUD. The likelihood of that option being adopted will be affected by the inflation print for the March quarter which is released on April 23. Recall that the surprise 0.9% print for core inflation in the December quarter which could be directly attributed to the fall in the AUD through 2013, prompted the Bank to abandon its rhetoric on the Australian dollar preferring in the February minutes to only note that the previous fall in the currency would assist the rebalancing of growth.
If the March quarter CPI indicates that the impulse effect of the fall in the AUD has passed through without any secondary implications for inflation, i.e. core inflation returns to a 0.6% print, then the Board could well be tempted to resume the “uncomfortably high” language around the AUD. However with today’s minutes highlighting a tentatively more confident outlook for the domestic economy it is extremely unlikely that it would resume commentary about scope for lower rates.
That would be inconsistent with the tentative evidence that prospects for the real economy are firming. In today’s minutes it was noted that: “a range of indicators of labour demand suggested a modest improvement in prospects for employment”. Note that the Board still expects the unemployment rate to “edge higher for a time” ( the recent fall in the unemployment rate from 6.1% to 5.8% was not known at the time of the April Board meeting.).
Commentary around the housing market continues to firm : “a strong pick up in dwelling investment was in prospect”; “housing market conditions remain strong”.
Consumer demand is described as having “strengthened a little” and retail sales are noted as “continuing the pick up in momentum that began in mid 2013” although liaison points to some easing more recently.
The Board is still only tentative around the outlook for business investment noting that “businesses were still somewhat reluctant to commit to major investments” although pointing out that business conditions were around average levels and above levels recorded in 2013.
The outlook for interest rates remains stable and the term “the cash rate could remain at its current level for some time if the economy was to evolve broadly as expected” figured in both the March and April minutes. Note that the Board pointed out that market rates continue to imply the cash rate was expected to remain unchanged over the remainder of the year.
International conditions were generally unchanged from March although it was indicated that China would likely experience the continuation of the easing in economic growth that started in the latter part of 2013.
Conclusion
On March 17 Westpac changed its outlook for the RBA cash rate from expecting two more cuts to stable rates with the next move to be up in the second half of 2015.
Evidence from these minutes are consistent with that view with a modest firming in the domestic economy providing the Bank with sufficient encouragement that lower rates will not be necessary. Of course there is always a possibility that rates may be reduced to lower a significantly overvalued AUD but a level of the AUD given the domestic momentum that would trigger such a policy action seems a very long way from here. After all, measures of financial conditions, particularly as they relate to the currency, are notoriously unreliable. It is more prudent to assess the state of the domestic economy as the key indicator as to whether lower rates are needed. As discussed above, the labour market; housing; consumer spending; and business conditions all point to sufficient modest improvement to preclude the need for lower rates.
On the other hand the sheer modesty of this recovery coupled with ongoing uncertainty in the global economy indicate a low probability of more imminent rate hikes.
