RBA's upbeat statement raised GDP and CPI forecast

RBA's upbeat statement raised GDP and CPI forecasts

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The Reserve Bank followed its shock decision Tuesday to leave the cash rate steady at 3.75% by today releasing another upbeat assessment of the economy in the Statement on Monetary Policy (SoMP). Indeed, as we anticipated, the tone of the language again was buoyant, an echo of the statement delivered Tuesday. Also, as we anticipated, the RBA revised modestly higher the GDP growth and inflation forecasts.

The optimistic tone of the commentary would have rested comfortably with the RBA having lifted the cash rate this week which, of course, it did not. Instead, as was indicated on Tuesday, RBA officials kept the cash rate steady because they are unsure how, and how quickly, the earlier rate hikes will wash through the economy. The uncertainty is heightened now by the fact that, by out-hiking the central bank, the Aussie commercial banks added considerably to the impact of the RBA’s three moves, a point highlighted in today’s statement. In fact, the statement characterised the monetary tightening thus far as “material”.

In particular, the RBA wants more clarity on how households are coping with the earlier rate hikes before hiking again. This important issue is unlikely to be resolved quickly. Yesterday’s soggy retail sales outcome for December hints that households reacted badly to the third hike in December, but it came after a big bounce in sales in November. Further on the consumer, next week’s confidence reading probably will bounce to an all-time high, given that households got an unexpected reprieve on their borrowing costs this week. The likely mixed messages on households’ behaviour means the cash rate could be on hold for some months.

The RBA clearly is in no rush to push the cash rate closer to a neutral setting – Board decisions in coming months, therefore, will be data-dependent, with the consumer and labour market indicators the most likely bell-ringers. What is clear is that stage one of the tightening cycle – the removal of the emergency component of earlier policy settings – is complete. Stage two, moving the policy stance from “normal” to “neutral”, will start when RBA officials are satisfied the consumer has taken the rate hikes in its collective stride. A precise cash rate consistent with a neutral stance is difficult to pin down, but it is a long way north of the current 3.75%.

The updated official growth and inflation forecasts now more closely resemble our own. To summarise, the statement pushed up the growth forecasts by 0.25% points at key dates in the forecast horizon, in line with our expectation. On inflation, the forecasts also were raised by 0.25% points, which now means the official view is that core inflation will trough at the mid-point of the 2-3% target range. The SoMP repeated the RBA’s sentiment from Tuesday that the cash rate probably has further to rise - we couldn’t agree more. In fact, the RBA’s forecasts assume a cash rate rising in line with market forecasts, which currently imply a 4.5% rate by the end of 2010.

On the domestic economy, officials believe Australia’s economy is performing well – much better than expected during 2009. The SoMP highlighted the recent positive developments in the labour market (i.e. the jobless rate has peaked at a much lower level than anticipated a year ago), the health of consumer confidence and household balance sheets, the buoyancy of the housing market, and the rapidly improving business investment outlook. This is especially so in the mining industry and, in other industries, is despite still tight credit conditions. The statement makes clear, though, that the economy is embarking on a new expansion with a limited amount of spare capacity. On offshore conditions, the statement again highlighted the importance of Australia’s trade links with the strongly growing economies in Asia.

The problem from here is that, if Board members this week were unsure how households would react to the rise in borrowing costs late last year, why would they be any the wiser in three and a half week’s time, at the March Board meeting? They may be better informed, but there is an unusually short four-week time span between the February and March Board meetings. The likely absence of further meaningful information on the consumer hints that the RBA will be on hold until at least the April Board meeting. Thereafter, though, we expect an extra “catch-up” 25bp rate hike in the second half of 2010, which means our end-year forecast of 5% is unchanged.

ENDS