RBA Governor's Testimony Highlights Uncertainty

RBA Governor's Testimony Highlights Increased Uncertainty

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Reserve Bank Governor Glenn Stevens today testified before a Federal Parliamentary committee in Canberra and answered questions from Members of Parliament. The discussion meandered from the Governor’s thoughts on the reasons behind the Bank’s decision to pause in February, to conditions in China and Greece, Aussie bank funding costs, house prices, labour market flexibility, and back again. As expected, the Governor’s opening statement was an echo of other commentary delivered in recent weeks, including this week’s minutes from the February Board meeting. As always, though, the question and answer session, which continues at the time of writing, was revealing.

The bottom line is that, having paused the tightening cycle earlier this month, following three rate hikes late last year, RBA officials are in no rush to hike again. In our view, the cash rate will rise a further 125bp over the remainder of 2010 but, given heightened uncertainty on how local consumers are dealing with the rate hikes already delivered, the next rise will not come until April. The Governor indicated that the cash rate is below “normal” (back in December, the Deputy Governor indicated that we had returned to a normal range) and that the pause in February was the “right call”, given the high level of uncertainty on key issues.
By the time of the next Board meeting in early March, we suspect Board members still will be uncertain about how the local punters are dealing with the earlier rate hikes. The heightened uncertainty and, given recent adverse sovereign events in Greece, and China’s latest policy tightening, should be sufficient to keep the RBA on the policy sidelines. The delay in following through with further tightening, though, in the context that the RBA’s core view on the economy does not seem to have changed, means the RBA will have to play catch up over the second half of 2010. The cash rate probably will be 5% by the end of the year, and in restrictive territory in 2011.

So, what prompted the pause, which caught every market economist on the hop? According to Mr. Stevens, the February decision to pause was made partly on the basis that the Aussie banks had out-hiked the RBA. This meant that the burden on households, and the uncertainty about how they would react, was larger than would otherwise be the case. Anxiety about the behaviour of households has been a consistent theme of recent RBA commentary, including this week’s Board minutes. It seems, though, that the sovereign events in Europe and the likely impact of policy tightening in China also were prominent in the RBA’s thinking. The sovereign debt issues in Europe, however, were important only at the margin.

On the domestic economy, the Governor reiterated the point made before that Australia seems to have emerged from the global downturn in better shape than most. We now are in a good position to benefit from rapid growth in our major export markets in Asia. The challenge now, according to Mr. Stevens, is to manage the next period of expansion, not limit damage in a downturn. Issues like capacity, productivity and flexibility, therefore, once again will take centre stage. On this, recent changes to labour laws add another level of complexity. According to Mr. Stevens, the flexibility available to Australian employers played a big role in limiting the rise in the jobless rate.

With the cash rate still very accommodative, the Bank’s seemingly rosy outlook for Australia – officials expect GDP growth to be above trend - indicates clearly that there are further rate hikes ahead. On the interaction of monetary policy and the Government’s mountainous (my description, not the Governor’s) fiscal stimulus, the Governor indicated that he believed the impact of the stimulus is at its peak now. This is partly owing to the impact of the improving economy.

On conditions offshore, the Governor indicated two key challenges. The first is that there seems to be a two-speed nature of the global recovery. In many of the smaller emerging economies, the recovery is V-shaped. In the larger developed economies, though, conditions remain mixed, with accommodative policy settings still playing an important role in supporting activity. The second challenge is the increasing focus on sovereign creditworthiness. Dealing with the substantial increase in the size of government balance sheets will require a “delicate balancing act”.

Next week’s speech by the RBA Deputy Governor is the only RBA event scheduled ahead of the March decision. Next week, though, also sees the release of the December quarter business investment survey – we expect a big upgrade to firms’ spending plans, which may influence the thinking of RBA Board members.

ENDS

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