At the June 7 Board meeting the decision was taken to keep rates on hold. We had expected that decision given the difficulties associated with raising rates only one week after the economy was reported to have contracted by 1.2% in the March quarter.
However we expected that the Governor would retain the hawkish language which had been adopted in both the Statement on Monetary Policy, May 6, and the minutes of the May Board meeting, May 17. These words which had been used in the past to lay the foundations for an imminent rate hike were “if economic conditions continue to evolve as expected, higher interest rates were likely to be required at some point if inflation was to remain consistent with the medium term target.” These words or some close version of them were not used in the Governor’s statement. True the final paragraph in this statement was an exact repeat of the final paragraph in the statement in May. But given the sharp increase in the hawkishness of the SoMP which printed three days after the Governor’s statement and was repeated in the minutes it is reasonable to have expected that if that urgency still dominated the Board’s thinking then those words would have been repeated in today’s statement.
With this no longer being the case we have to conclude that the Bank’s commitment to an early rate hike has been significantly diluted. Indeed even the May statement was more hawkish than this one today. Most importantly a paragraph in the May statement that included the observation “over the longer term inflation can be expected to increase somewhat if economic conditions evolve broadly as expected” was eliminated from this statement.
Apart from this decision to drop the more hawkish words on policy and the concern about longer term inflation the rest of the June statement is also slightly more dovish than the statement in May with observations such as: “investment intentions have been revised lower recently outside the resource sector”; “Australian Government spending programs now abating”; and “sovereign debt problems in Europe have been adding to financial market volatility.”.
On the other hand, the negative GDP print from last week is played down and indeed a positive spin is given to it: “a solid increase in aggregate demand”.
Conclusion
Our advice to customers based on our reading of the sharp increase in the hawkishness of the Bank’s rhetoric was that it would only have taken that decision to use that language if it was preparing the market and the community for an imminent rate move. To drop that language at this stage should be seen to be a significant decision but such has been the inconsistency of their communications it is difficult to ascertain exactly where the Bank is coming from. Our view has always been that an imminent rate hike was likely to do significant damage to an economy which outside mining is already weakening. However, it is our professional duty to interpret the Bank’s communications on face value. Others expected that the next move by the Bank will be the beginning of a sequence of moves while we have argued that due to the likely damage to the economy of a rate hike a follow-up move was unlikely and the next increase could not be expected until the June quarter 2012.
The decision to change the Bank’s rhetoric in this statement must be interpreted as a more cautious approach to the next rate decision. It has to cast considerable doubt on our position that while a move in June was unlikely, a July move was very much on the cards.
Clearly the Bank’s position is fluctuating and any move is now very much dependent upon the data flow.
We expect that there will be a very large employment print on June 9, which may lead to a significant fall in the unemployment rate and swing the debate back towards an early rate hike. However, precluding that event and taking this statement as we must, on face value, it appears that the case for a rate hike will probably have to await the next CPI which will print on July 27 for an August decision.
Bill Evans
Chief Economist
Westpac Institutional Bank
The RBA Statement in full:
Statement by Glenn Stevens, Governor: Monetary Policy Decision
At its meeting today, the Board decided to leave the cash rate unchanged at 4.75 per cent.
The global economy is continuing its expansion, led by very strong growth in the Asian region, though the recent disaster in Japan is having a major impact on Japanese production, and significant effects on production of some manufactured products further afield. Commodity prices have generally softened a little of late, but they remain at very high levels, which is weighing on income and demand in major countries and also pushing up measures of consumer price inflation. In response, a number of the countries with stronger expansions have been moving to tighten their monetary policy settings over recent months. Overall, though, financial conditions for the global economy remain accommodative. Uncertainty over the prospects for resolution of the banking and sovereign debt problems in Europe has increased over the past couple of months, which has been adding to financial market volatility.
Australia’s terms of trade are reaching very high levels and national income has been growing strongly. Private investment is picking up, led by very large capital spending programs in the resources sector, in response to high levels of commodity prices. Outside the resources sector, investment intentions have been revised lower recently. In the household sector thus far, there continues to be a degree of caution in spending and borrowing and a higher rate of saving out of current income. The impetus from earlier Australian Government spending programs is now also abating, as had been intended.
The floods and cyclones over the summer have reduced output in some key sectors. As a result there was a sharp fall in real GDP in the March quarter, despite a solid increase in aggregate demand. The resumption of coal production in flooded mines is taking longer than initially expected, but production levels are now increasing again and there will be a mild boost to demand from the broader rebuilding efforts as they get under way. Over the medium term, overall growth is likely to be at trend or higher.
Growth in employment has moderated over recent months and the unemployment rate has been little changed, near 5 per cent. Most leading indicators suggest that this slower pace of employment growth is likely to continue in the near term. Reports of skills shortages remain confined, at this point, to the resources and related sectors. After the significant decline in 2009, growth in wages has returned to rates seen prior to the downturn.
Overall credit growth remains quite modest. Signs have continued to emerge of some greater willingness to lend, and business credit has expanded this year after a period of contraction. Growth in credit to households, on the other hand, has softened, as have housing prices. The exchange rate remains, in real effective terms, close to its highest level in several decades. If sustained, this could be expected to exert continued restraint on the traded sector.
CPI inflation has risen over the past year, reflecting the effects of extreme weather and rises in utilities prices, with lower prices for traded goods providing some offset. The weather-affected prices should fall back later in the year, though substantial rises in utilities prices are still occurring. The Bank expects that, as the temporary price shocks dissipate over the coming quarters, CPI inflation will be close to target over the next 12 months.
At today’s meeting, the Board judged that the current mildly restrictive stance of monetary policy remained appropriate. In future meetings, the Board will continue to assess carefully the evolving outlook for growth and inflation.