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RBA: Cautiously optimistic as downside risks diminish

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The modest improvement in global economic conditions gave the Reserve Bank reason to feel cautiously optimistic about the current economic landscape: Reserve Bank Board members conceded that while “major downside risks were seen to remain, (but) the probability of a very bad outcome in the near future had receded a little further”.

On the domestic front, the Reserve Bank was well aware that the “economy continued to undergo significant structural adjustment in response to the very high terms of trade and the accompanying high exchange rate”. And the economy was more multispeed in nature; “most information thus far had indicated that weakness in parts of the economy – including manufacturing, building construction and parts of the retail sector – was being approximately balanced by the strength in the mining sector and some services industries.”

Despite the more upbeat view by the Reserve Bank, there were still downside risks to the global economy and given that inflation was well contained “there would be ample scope for the Bank to ease policy” if downside risks materialised.

What does it all mean?

What a difference four months can make. Slowly but surely the Reserve Bank is starting to feel more comfortable with current economic environment. In fact, one could go as far as to say that the Reserve Bank Board seems to be cautiously content after a heightened degree of concern in late 2011.

In fact, from an economic sense, interest rates are near long-term averages, inflation is in the middle of the target ban and economic growth is near trend. In short, there is no urgent need to cut rates again.

Board members remain generally optimistic about the medium term outlook for the domestic economy, largely due to the “improvement in the prospects for the global economy”. The fact that European policymakers were “making progress in addressing the regions debt and financial problems” was largely behind the Reserve Bank’s decision to keep interest rates on hold at the March Board meeting.

The Reserve Bank tend to be forward looking and it is interesting that in recent speeches by officials and even more so in these minutes the focus is now shifting to the challenges that the Australian economy is likely to face. And front and centre is the significant structural adjustment that is taking place across the economy. It is clear that the Reserve Bank is focused on ensuring that the Australian economy is able to deal with the structural shift that is taking place as a result of the “very high terms of trade” and “accompanying high exchange rate”.

In addition, the Reserve Bank Board members discussed the self-induced slowdown that is taking place in China. While they remain quietly confident that growth will continue to bubble along at a healthy pace, the focus seems to be on the Chinese property market. The watching brief seemed to be centred on the slowdown in the Chinese property sector and the threat of any flow-on effects to the broader economy.

The Reserve Bank does not seem to be done when it comes to cutting interest rates, rather it seems more likely that policymakers are being more strategic in the timing of any future rate cuts. The next batch of inflation data (in late April) is likely to give central bank authorities a better picture of the inflation landscape.

Overall, the Reserve Bank Board minutes describe a more upbeat central bank compared with a couple of months ago. However, there are still risks that can materialise and that is why CommSec still expects one further rate cut to take place in May. Another rate cut would help to shore up domestic confidence rather than providing any significant degree of stimulus.

What do the figures show?

Minutes from the March 2012 Reserve Bank Board meeting

“Members noted that the past month had seen an improvement in the prospects for the global economy, with European policymakers making progress in addressing the region's debt and financial problems. Major downside risks were seen to remain, but the probability of a very bad outcome in the near future had receded a little further”.

“Conditions in most euro-area sovereign debt markets had improved over the month and some progress had been made with agreement on the Greek bailout package lowering the near-term probability of a severe financial event that many had feared late last year.”

“Chinese authorities had been successful in slowing growth to a more sustainable pace. The property market remained subdued, in large part reflecting administrative controls, including restrictions on access to credit by property developers and limits on purchases by existing property owners. These measures were having their intended effect of reducing property prices, but affordability for new buyers remained a concern of the central government.”

“The US economy had emerged from its soft patch in mid-2011. The labour market had showed further signs of improvement, as indicated by the trend decline in initial jobless claims to levels last seen in 2008. Housing activity had also shown some improvement, albeit from a low base.”

“The domestic economy continued to undergo significant structural adjustment in response to the very high terms of trade and the accompanying high exchange rate. A key question was whether the necessary adjustment was occurring at an overall pace of growth that kept the economy close to trend and inflation close to target. In this regard, most information thus far had indicated that weakness in parts of the economy – including manufacturing, building construction and parts of the retail sector – was being approximately balanced by the strength in the mining sector and some services industries.”

“Members were also alert to the uncertainties inherent in assessing the response of the domestic economy to the disparate forces at work, including the very large rise in resources investment and the high exchange rate. To date, the unemployment rate had remained at a low level and inflation broadly consistent with the medium-term target.”

“On balance, the Board considered that it was appropriate for interest rates to be around their average levels, which was judged to be the case at present. The Board would continue to monitor both how the global economy evolved and the course of domestic economic activity and prices.”

What is the importance of the economic data?

The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.

What are the implications for interest rates and investors?

CommSec still believes that the Reserve Bank should cut rates again, and we are pencilling in a move in May. In short, economic growth is still below trend and inflation is well controlled. The Reserve Bank can inject momentum with few, if any, downsides for the economy.

Published on: Wednesday, March 21, 2012

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