RBA: Start of an extended rate pause?

Reserve Bank Board meeting

·         The Reserve Bank Board has left the cash rate at 4.75 per cent at its second meeting for 2011. The next meeting is on April 5 2011.

·         The Reserve Bank Board provided a relatively short accompanying statement. The statement suggested that the Reserve Bank remains comfortable with how labour market conditions are evolving at present –noting that “reports of skills shortages remain confined, at this point, to the resources and related sectors. After the significant decline in 2009, growth in wages has returned to rates seen prior to the downturn.”

What does it all mean?

·         Given the amount of commentary we have received from the Reserve Bank over the past couple of weeks it is no surprise interest rates have been left on hold, and the accompanying statement is relatively short. Since the last rate decision we have had no less than two Reserve Bank speeches, the release of the last board minutes, plus the latest monetary policy statement and the Reserve Bank Governors testimony to the House of Representatives Standing Committee on Economics. So it is hardly surprising that the central bank is pretty much talked out.

·         Clearly the Reserve Bank is in wait and see mode. As the Governor alluded to in his testimony to parliament, the central bank is ahead of the game (on the rate front) and as such can afford to wait and monitor developments in coming months. The Reserve Bank is certainly showing no tendency to act on interest rates. The $64 question is how long will they remain on the sidelines.

·         From the Reserve Bank’s perspective the economy is certainly throwing up some conflicting thematics. Key sectors of the economy remain weak, consumer spending remains sluggish but on the other side of the equation the high terms of trade, or injection of income into Australia, has been at the forefront of Reserve Bank concerns. The terms of trade boost continues to gain traction and remains well ahead of Reserve Bank forecasts. Added to which last week’s CAPEX data suggests that businesses are banking on a second half recovery with future investment plans being ramped up.

·         The Reserve Bank has once again reassured borrowers that it will look through the impact of the floods on activity and prices. And while growth is expected to be subdued in the near term, the rebuilding phase in the second half of the year will ensure a robust turnaround in activity levels. We think that investors should still be working on the assumption that rates will be higher at the end of the year.

·         In the second half of the year we expect the Queensland rebuilding work to be fully underway. At the same time the domestic job market will be tightening, consumers will start spending again while the global economy will be motoring at a near 4.5 per cent annual rate. So the cash rate may be closer to 5.50 per cent at year end rather than the current rate of 4.75 per cent.

Interest rate decision and past cycles

·         The Reserve Bank Board has left the cash rate at 4.75 per cent. In October 2009 the cash rate stood at a 49-year low of 3.00 per cent. But then the RBA embarked on a process to remove the emergency stimulus, lifting the cash rate by a quarter of a percent in October, November and December 2009, and then in March, April, and May 2010 and following it up with a move in November.

·         In the last rate-cutting cycle the cash rate fell to a low of 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.

·         In response to funding pressures, banks have been forced to lift rates above the cash rate over the last year. As a result, the Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.80 per cent, well above the long-term average or “normal” rate of 7.15 per cent.

·         The Reserve Bank can afford to stay on the interest rate sidelines for a few months. Key sectors of the economy are going backwards, like services and construction. Inflation is lower than the Reserve Bank had previously expected and the outlook is mixed. Retailers are still slashing prices, the higher Aussie dollar is pushing down prices of imported goods but the floods will lead to higher fruit and vegetable prices.

·         The statement from the December meeting is on the left; the statement from today’s March 2011 meeting is on the right. Emphasis has been added to significant changes in wording in the recent statement.

What are the implications of today’s decision?

·         The Reserve Bank is clearly in ‘wait-and-see’ mode on interest rates. A sustained period of interest rate stability should boost consumer and business confidence levels and eventually get people to start spending again. This is clearly great news for all concerned, allowing Aussies to get on with life.

·         Even though rates are on hold, the threat of higher rates in the later part of 2011 together with lofty utility charges and higher petrol prices will ensure that consumer conservatism continues well into the second half of the year. Simply, if you factor in higher rates over the next year then you have the best chance of maintaining your current lifestyle without major disruption.

·         Most people will probably tell you that their finances are in reasonable shape, but they just don’t want to do anything new at present, whether it is making a major purchase or investment.

·         The decision to leave rates unchanged is clearly positive for retailers and other consumer-facing businesses.

Important Information

The summary and attached report has been prepared without taking account of the objectives, financial situation or needs of any particular individual. For this reason, any individual should, before acting on the information in this report, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice. In the case of certain securities Commonwealth Bank of Australia is or may be the only market maker.