Interest rate outlook - RBA seeks to calm the storm
Event
§ The Reserve Bank of Australia (RBA) cut the cash rate by a further 25bp, to 3.5% at its June policy meeting, a rapid follow-up to the more aggressive 50bp easing of May. This takes the total easing in this cycle to 125bp from 4.75% in November 2011.
Impact
§ The RBA's focus on the "weaker and more uncertain international environment", while altering very little of its underlying commentary on the Australian economy, suggests that its decision should be seen as a precautionary measure aimed at shoring up confidence, rather than a reaction to soft domestic economic conditions.
§ And in our view, the RBA is unlikely to continue cutting rates simply as a precautionary measure against the risk of something bad occurring. Hence this could point to a period of stable rates in the next few months, contrary to current market expectations.
Outlook
§ The RBA highlighted that "modest domestic growth and a weaker and more uncertain international environment" were the key factors in its decision.
§ To take each of these two factors in turn, it is worth noting that the RBA appears to have not changed its view on the domestic economy, with the accompanying statement reading similar to previous assessments - divergent outcomes between sectors, with a still high terms of trade and a firm labour market combined with soft business and consumer confidence and weak credit growth. That is, there do not appear to have been any major developments in the past month that have changed the RBA's view of the domestic economy and would justify a move in the policy rate.
§ But what has changed, clearly, is the international environment. And the RBA highlights "further weakening in Europe and some further moderation in growth in China", combined with a deterioration in financial market sentiment over the past month. Yet interestingly, the RBA also focuses on these risks as a "potential source of adverse shocks". That is, the RBA has chosen to lower rates now on the risk that these events materialise, and in order to shore up confidence, rather than wait for them to unfold.
§ The question, therefore, is where to from here? In our view, should the worst case scenarios around a hard landing in China or a significant default event in Europe occur, the RBA will clearly be ready to lower rates again. But the RBA is unlikely to continue cutting rates simply as a precautionary measure against the risk of something bad occurring. This could point to a period of stable rates in the next few months.
§ Indeed, there was an interesting change in the RBA’s language around inflation this month – essentially shifting from noting that low inflation was ‘affording’ room to lower the policy rate, to having ‘afforded’ the room. That is, the RBA may well be comfortable with the current policy setting given its outlook for the domestic economy. That said, we do expect the RBA to cut rates later in 2012 as the domestic economy flags later in the year.
Indices:
The All Ordinaries Index was flat decreasing -3 points (or -0.09%) since closing last Friday to 01:45 pm Today.
The rest of the world as measured by the MSCI index is up +37 points (or +3.2%) from closing last Friday to end of trade Thursday.
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