· The RBA again kept the cash rate unchanged at a record low of 2.75%, while retaining an easing bias.
· The RBA is happy with the lower AUD and would like to see further weakness.
· We see rates on hold with an easing bias for an extended period given the end of the mining capex boom.
The RBA again kept the cash rate at a record low of 2.75% and retained its tempered easing bias. After cutting the cash rate to 2.75% in May, the RBA has now left the cash rate steady for two months in a row (Barclays, consensus and shadow RBA board: 2.75%; market pricing: 14% chance of a 25bp rate cut). No change in rates had been widely expected given the recent steep slide in the AUD, which is now 12% below its April peak on a trade-weighted basis. The RBA still thinks that “easier financial conditions… will contribute to a strengthening of growth over time”, but retained its easing bias, noting that “the inflation outlook… may provide some scope for further easing, should that be required to support demand” (back in April, the bias was framed in slightly stronger language as “the inflation outlook would afford scope to ease further, should that be necessary”).
The statement was again much shorter than usual, and the RBA’s outlook was little changed. Global growth is a “bit below average”, but there are “reasonable prospects of a pick-up next year”, and international financial conditions are “very accommodative”. Local growth has been a “bit below trend” and that should continue in the near term as the “economy adjusts to lower levels of mining investment”. Unemployment has edged higher and inflation is expected to remain consistent with the 2-3% target, “notwithstanding the effects of the recent depreciation of the exchange rate”. The discussion of business investment was limited to the reference to lower mining investment, where the bank seems more confident that mining capex is about to start to return to normal (we actually think that mining capex may have already peaked).
Easier policy is working, but the RBA would like to see the exchange rate fall further. Lower interest rates are boosting interest-sensitive spending and asset prices and “further effects can be expected”. Credit is subdued, although there are signs of “increased demand for finance from households”. The exchange rate has fallen, but “remains at a high level high” and it is “possible that the exchange rate will depreciate further over time, which would help to foster a rebalancing of growth in the economy”.
Fed tapering may see more volatility in markets. The RBA noted that the market is rethinking the outlook for US monetary policy, which has seen a “noticeable rise” in bond yields from “exceptionally low levels”. The RBA also highlighted the increase in volatility in markets and noted “some widening in credit spreads”. We imagine that the RBA will be alert to further disruptions, but would see a winding back of unconventional policy measures in the US as helping in the adjustment of the AUD.
We see the RBA remaining on hold with an easing bias. RBA Governor Stevens is speaking at lunchtime tomorrow, and although no topic has been announced, we imagine that he will talk on the economy given he is addressing the Queensland branch of the economic society. As such, he may decide to downplay recent talk of recession by some commentators, while hoping for a further decline in the exchange rate in order to help the economy adjust to the end of the mining boom. Although it is hard to quantify the impact of the lower exchange rate on the economy, our work suggests that a 9% drop in the exchange rate has about the same effect as a 100bp rate cut, while the RBA’s own dated research shows an even looser trade-off of 18% on the currency equalling a 100bp cut, albeit with a more immediate effect on growth.
The next CPI is a key risk to our view, although the RBA is expecting a low result for Q2. Past the governor’s speech and the next round of employment data, the Q2 CPI is due on 24 July. The RBA’s forecast profile for annual inflation suggests that the bank is already anticipating a low result, as it implies a pick-up in quarterly underlying inflation from 0.4% to about 0.5%. Assuming that the AUD is still trending lower by that date, the RBA is likely to believe that this marks the low-point for inflation, although the pass-through from a lower currency to underlying inflation is quite drawn out, with a faster and more noticeable impact on headline inflation.
Barclays