Bottom line:
Going into the Reserve Bank of Australia (RBA) December board meeting, commodity price and global PMI developments and historical precedent suggested to us that an easing cycle had started. While we sensed no urgency in RBA commentary going into the meeting, with the possible deferment of action to February, this week’s rate cut and changes in the concluding comment phrasing in the RBA statement has seemingly upped the ante for further easing. Accordingly, we have lowered our cash rate target to 3.50% from 3.75% and brought forward the moves to Q1 and Q2 12. In other words, an RBA easing cycle of some magnitude is already seemingly baked into the cake with only a rapid rebound in the global PMI truncating it.
Easing cycle has started
Going into the RBA December board meeting, we were forecasting a 3.75% cash rate by mid-2012. We had lowered our cash rate forecast from no change for 2012 following the RBA’s November rate cut. Support for this view, in our opinion, was found in the fact that:
- The RBA doesn’t appear to ‘fine tune’. Over the past 20 years, once it starts easing, it tends to implement a series of rate cuts;
- The 6m change in the non-rural index of commodity prices moved into negative territory in November for the first time since late 2009. Declining commodity prices tend to be associated with easing cycles (Figure 1); and
- Moreover, the RBA believed the terms of trade had peaked and expected it to decline further.
Figure 1: RBA cash rate vs 6m change in RBA’s non-rural index of commodity prices
Source: Bloomberg, Barclays Capital
Our analysis outlined in Global PMI says RBA easing cycle is baked into the cake, 5 December 2011, which linked the global PMI to the AU 3y yield and cash rate, suggested that market pricing (3.0% cash rate by June-12) was consistent with the global PMI around current levels. Moreover, a gradual rebound in the global PMI over coming months only marginally reduced the degree of RBA easing that appears to be warranted (Figure 2 and 3). In other words, an RBA easing cycle of some magnitude is already seemingly baked into the cake with only a rapid rebound in the global PMI truncating it.
Figure 2: Global PMI, three scenarios
Source: Bloomberg, Barclays Capital
Figure 3: Cash rate (%) outlook under three global PMI scenarios
Source: Bloomberg, Barclays Capital
Change of phrasing = change of heart?
Despite our cash rate forecast and market pricing, we had our doubts that RBA commentary had displayed any sense of urgency going into the December board meeting. Accordingly, our decision to defer our expectation of RBA action to February related to timing rather than any questioning of the likelihood of further easing. As it turned out, the RBA did ease in December. We believe this action alone throws considerable weight behind the “its an easing cycle” argument. Furthermore, the RBA sent a significant signal of further action, a conscious decision, in our opinion, by changing the phrasing in its concluding comment (see below).
- Dec-11 statement – “The Board will continue to set policy as needed to foster sustainable growth and low inflation over time.”
- Nov-11 statement – “With overall growth moderate, inflation now likely to be close to target and confidence subdued outside the resources sector, the Board concluded that a more neutral stance of monetary policy would now be consistent with achieving sustainable growth and 2-3 per cent inflation over time.”
Interestingly and not by chance, in our opinion, the phrase to “set policy as needed to foster sustainable growth and low inflation over time” appears very similar to the concluding comment that the RBA utilised in rate decision statements during the 2008-09 period (see below).
- Nov-08 statement – “The Board will continue to monitor developments and make adjustments as needed to promote sustainable growth consistent with achieving the 2-3 per cent inflation target over time.”
In our view, this signals a willingness by the RBA to push policy into accommodative territory. Indeed, at face value, the new phrasing potentially signals a willingness to move in larger than 25bp increments given the 2008-09 precedent. Accordingly, we have lowered our cash rate target to 3.50% from 3.75% and brought forward the moves to Q1 and Q2 12.
BARCLAYS CAPITAL
INTEREST RATES RESEARCH | ASIA-PACIFIC INSTANT INSIGHTS