Wednesday, February 06, 2013

Reserve Watch: Why it's on standby to cut again

The Reserve Bank is on standby to cut interest rates once again if the economy falters.

In an unusual statement accompanying Tuesday’s decision to keep rates on hold Reserve Bank governor Glenn Stevens said there was a need for “accommodative stance” on rates.

Should it be necessary he had “scope to ease policy further”.

The Bank believes the mining investment boom is about to peak. Beyond that it sees very little to pick up the slack. Private investment is weak. Government projects have been curtailed to help the Commonwealth deliver a surplus and to help states cope with budget problems.

Only in residential investment were there signs of signs of growth, and to date they have been small and centred around the construction of units rather than houses.

The Bureau of Statistics house price index climbed 2.9 per cent in Perth during the three months to December, by 2.3 per cent in Sydney and by just 0.7 per cent in Melbourne.

Of critical importance to the Bank will be the official survey on investment intentions due at the end of the month. If it points to an imminent downturn in mining investment and to little new non-mining investment to take its place the Bank will be minded to act.

It meets five days later.

The Governor’s statement makes clear the Bank would not need to wait for confirmation that inflation is low before acting. It says both the headline and underlying inflation rates are close to 2.25 per cent, well below the centre of its target band. It expects inflation to remain near the centre of its target band for the next one to two years. Keeping inflation low are rising unemployment, “working to contain pressure on labour costs” and cost-cutting by businesses in the face of moderate demand growth. The Bank says these should keep inflation low, even as the effects of the higher dollar pass.

Mr Stevens says international economic conditions look better than they did when the board last met in December. The iron ore price has climbed a further six per cent to $US153 a tonne. But the Bank does not expect the high price to last, believing if high demand continues, low-quality high-cost mines in China will reenter the market knocking down the global price.

Domestic conditions are improving. The Bank says some categories of consumer spending have picked up and savers are starting to chase higher returns. But both consumers and businesses are cautious. The dollar, which is “higher than might have been expected” is weighing on business.

“The Bank sees scope for a stronger non-mining economy,” said UBS economist Matthew Johnson. “If it does not pick up, the Bank will cut to make sure it does. Our model currently suggests a 62 per cent chance of a cut in March.”

In today's Sydney Morning Herald and Age

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