The minutes of the Monetary Policy meeting of the Reserve Bank Board for February provide further insight into the Board’s thinking behind the decision to cut rates. This complements the Statement on Monetary Policy (SoMP) and the Governor’s testimony to the House of Representatives Standing Committee on Economics.
This is a difficult document to write given that the case needs to be made for the rate cut but most readers will be much more interested in the forward guidance.
The most important forward guidance which the Bank has delivered so far has been to assume “market pricing” for the interest rate outlook in its forecasts for the SoMP. At that time the market had priced in a further 25bp cut by May – by adopting that pricing it was implied that the Bank fully expected to cut rates again and certainly by May.
With the announcement that Australia’s unemployment rate had jumped from 6.1% to 6.4% in January, markets moved to aggressively embrace prospects for a cut by March.
A key issue is whether the Bank sees that adverse development as reason to further downgrade its already pessimistic outlook for the labour market or is inclined to dismiss it as “one month” volatility. Certainly it was a shocking move and one that , at least, would confirm their concern with the labour market.
Last week in writing on the Westpac-Melbourne Institute Index of Consumer Sentiment in February we noted: “For now, we are comfortable to maintain our original call [made on December 4] that the Bank would cut in both February and March. However we recognise that a perfectly respectable case can be made for the Bank to pause for a month or two to assess developments in the housing market”.
This observation is further supported in the minutes with the use of the sentence ( which first appeared in the SoMP) : “Given the large increases in housing prices in some cities and ongoing strength in lending to investors in housing assets members also agreed that developments in the housing market would bear careful monitoring”.
On the other hand , the Governor gave a balanced view on the housing market in his recent parliamentary testimony,” Price rises in Sydney are very strong, and they are pretty solid in Melbourne. On the other hand they are much more mixed elsewhere. Excluding Sydney, the rise for Australia as a whole over the past year was about 5 per cent. That is a healthy pace but not alarming.”
The sense of the Bank waiting a month or two for the follow-up cut is further strengthened by the following sentence in the minutes: “In deciding the timing of such a change members assessed arguments for acting at this meeting or at the following meeting. On balance, they judged that moving at this meeting which offered the opportunity of early additional communication in the forthcoming Statement on Monetary Policy was the preferred course.” This could, but not necessarily should, be interpreted that, at the time of the meeting, the board wanted one or the other but not both months.
“Communication” was always our argument for beginning the easing cycle in February rather than waiting for March.
Given that we have held the” February to be followed by March” call since December 4, on balance, we still see that as the best policy and the most likely outcome.
However, as noted above, waiting for a month or two would not come as a significant surprise.
Other incentives to wait, if the Bank is uncertain, would be to assess momentum in the December quarter with the national accounts that will be released on the day after the March meeting.
A major cost in delaying the next move is that the Australian dollar might start responding to a benign rates outlook. Note that the AUD has already traded back up to near USD 0.78 , its level prior to the February rate cut.
Commentary in the minutes pointed out that markets had, at the time, priced the Fed’s first rate hike back to year’s end whereas the governor in his testimony predicted,” in a few months from now”. This updated view on the FED might encourage the Bank to wait on the assumption that further downward pressure will exerted on the AUD. However, that adjustment should already have happened given the strong conviction in markets now that the FED is readying to move in June.
The key point is that the reasons given by the Bank in its recent communications , including the minutes, justify more than one move in total .; “ restrained pace of wage increases;”; “ low rates of inflation likely to be sustained”;” a lower exchange rate was likely to be needed” ;”fewer indications of near term strengthening in growth than previous forecasts would have implied” ;”unemployment rate likely to peak a little ( and later) than in the previous forecast”.
Indeed the risks are much more skewed to more than two moves in total rather than no more moves at all.
Certainly international investors see Australia’s rate structure as being far too high even with a cash rate of 2.25%.
Conclusion
These minutes , on balance, cast more doubt on a follow up move in March. While a March move to follow up February has been our core call since December 4 we can see that “ a respectable case can be made for the Bank to pause for a month or two “ but a second cut still seems extremely likely.
For now, we maintain our original call , particularly watching the AUD over the course of the next few weeks. It is our view that the Bank has considerable scope to ease further and the best policy is to maintain downward pressure on the AUD. The somewhat uncertain outlook for rates which is implied in these minutes might prove to be counter-productive in delivering the Bank it’s likely USD 0.75 target.
That may become apparent over the course of the next few weeks
Bill Evans
Chief Economist Westpac