Wednesday, November 07, 2012

Behind the RBA "surprise". Why December is a good bet

The Reserve Bank is fully prepared to cut interest rates at its next meeting on December 4, but the statement released after its Tuesday board meeting reveals it’ll be no pushover.

The Bank went out of its way to describe interest rates for borrowers as “clearly” below their medium-term averages. It subscribes to a notion made popular by its previous governor Ian Macfarlane that the further rates move from neutral the stronger the case that needs to be made to move them further away still.

It sees signs the five cuts it has delivered since Melbourne Cup day 2011 are “starting” to have the desired effects. Business demand for funding is up, housing is stronger and share prices have climbed in line with markets overseas. It is looking for “further effects” over time. If it gets them, and if they are strong enough, it might feel the economy doesn’t need another interest rate boost. It would like to see a clear case for a cut before cutting again - clearer than it needed in order to begin to cut.

It is somewhat concerned about inflation (which has been “slightly higher” than expected) but not concerned enough to rule out another rate cut and, importantly, not concerned enough to make it delay any rate cut under after the release of the next consumer price index in late January.

The board believes that by its next meeting in December - its last for the year - it’ll get a good enough steer on inflation from the wage price index, due for release next Wednesday. It will also have the latest figures on investment intentions, something to which it is now paying very close attention as it worries about the transition from mining investment to other forms of investment after the boom peaks some time next year.

Late Tuesday the market was assigning a 58 per cent probability to a rate cut in December, which is probably about right. The Bank is worried about unemployment edging higher (although it recognises this will help control inflation) and it believes some of the jump in consumer spending in the first half of the year was only temporary, created by early carbon tax compensation payments.

The Australian dollar jumped to its highest point in six weeks after the Reserve left rates steady, climbing more than half a cent to 104.27 US cents, in a move that can’t have made the Bank happy. It would like to crimp the dollar which it thinks is “higher than might have been expected”. It is now ‘leaning against the wind’ by selling Australian dollars where foreign customers want to buy them, but it doesn’t want to cut rates in order to restrain the dollar because it fears it mightn't work. It’ll cut rates only the case stacks up on its own terms, which isn’t yet.

In today's Sydney Morning Herald and Age

Related Posts

. Melbourne Cup? No cut.

. October: Why the RBA cut. The resources boom is about to peak

. September: Situation no longer normal. The Reserve prepares to ease