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RBA testimony signals cash rate may have peaked

RBA Governor's testimony signals that cash rate may have peaked in March

RBA indicated again that domestic demand growth is slowing

RBA Governor Glenn Stevens today delivered his six-monthly testimony to Federal Parliament's House Economics Committee. As usual, the Governor read a prepared statement, the tone of which adhered closely to the commentary delivered after Tuesday's Board meeting, and took questions from Committee members. The main message from today's hearing was that the lingering uncertainty in global financial markets and the early evidence that growth in domestic demand has slowed mean the RBA is treading more carefully than before. Reflecting this, the RBA left the cash rate unchanged on Tuesday, having earlier raised the cash rate three times in five months.

The clear shift in the tone of RBA's commentary this week means our level of conviction in forecasting a 25bp rate hike in early May has dropped significantly. If indicators of domestic demand continue to weaken as RBA officials expect, and conditions in global financial markets remain difficult, the tightening cycle could well have ended in March. Today's retail sales data for February, for example, surprised on the downside of market expectations to show another small decline. This strengthens the perception that domestic demand is cooling in a material way, but conditions in global financial markets, while still problematic, have eased recently.

The RBA Governor today highlighted that while growth in domestic demand is slowing, the moderation is tentative and in its early stages. Also, the Governor indicated that labour skills shortages remain a problem for many firms, that employment growth is robust, and that the terms of trade, which has been a major source of national income in recent years, is likely to rise another 15% from here. The clear inflationary impact of these factors was a trigger for the recent rate hikes. Also, the new Government remains committed to pushing through the personal income tax cuts in July, which probably will trigger a bounce in consumer spending in 3Q.

There is, therefore, more uncertainty about the near term policy outlook than futures market pricing indicates. The outcome of the Q1 CPI print on 23 April, therefore, remains critical. An unexpectedly high outcome - with the headline inflation running above 4%, for example, and core inflation spiking up towards 4% - could still be enough to get the RBA over the line in May. In fact, not tightening policy with evidence that inflation was running away seemingly unchecked will take some explaining. As the Governor pointed out today, though, difficult financial market conditions and downgrades to GDP growth forecasts for the major offshore economies retain prominent places on the RBA's radar screen. These may be enough to offset even an unexpectedly bad CPI print later this month.

One thing, though, is clear from the tone of the Governor's testimony - the RBA will not be cutting the cash rate any time soon. Only a serious setback for the global economy or financial markets, with significant adverse implications for Australia, could trigger rate cuts this year - RBA officials have shown during the credit market turmoil that their threshold for "emergency" cuts is extremely high. If the tightening cycle did end in March, the RBA almost certainly will leave the cash rate on hold for an extended period, to make sure the inflation dragon has been slain.


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