Australian Central Bank Leaves Options Open

August 11, 2008

At its monthly interest rate policy meeting last week, the Reserve Bank of Australia shifted to an easing bias one month after abandoning a restrictive bias for a neutral stance.  The Bank released its quarterly monetary policy statement overnight to expand further on its latest thinking.  The statement did not guarantee the timing of the first rate cut, although September 2nd seems likely, and it failed to validate the view that had been growing that a 50-basis point reduction to 6.75% would be implemented then.  The previous easing cycle had kicked off with a 50-bp cut in February 2001, but all 12 tightening moves between May 2002 and March 2008 had a 25-bp size.

The case for an easing bias rests on assumptions of weakening global demand and observations of “a significant moderation in domestic demand” caused by “tighter financial market conditions, declining asset markets, and higher fuel costs.”  Officials in particular worry that the slowdown in G7 growth will spread to China, India and other emerging markets.  The controversial nature of the shift in policy bias is that projected CPI inflation has been revised upward to 5.0% from 4.5% for all items in the year to end-2008 (with core then at 4.5%, revised up from 4.0%).  Inflation at mid-2009 has been revised up 25 basis points to 3.75%.  The path for prices thereafter is the same as forecast three months ago, and does not show in-target, sub-3% being restored until 2H10.

As expected, future economic growth has been revised lower but not radically so, with GDP rise 2.25% in the year to mid-2009 and 2.5% in the year to mid-2010.  A mitigating growth stimulus will be the 20% rise of the ratio of export prices to import prices since the start of 2008.  Nonetheless, officials are now more worried about the risks of lower-than-assumed growth than of higher-than-projected inflation.  A decision on how quickly to cut rates has not been made, nor should such a pre-commitment have been made.  Three weeks remain before the next policy meeting, and officials will want to assess the weakness in Australian domestic activity and demand, especially the housing market and retail sales.  They will want to see the latest figures for credit growth, which has slowed sharply, and they will comb all information on trends in Australia’s export markets and commodity prices.  Last week’s post-meeting statement had not called present rates “appropriate,” but today’s quarterly analysis did conclude “the existing monetary policy setting was appropriate for the time being.”  The inclusion of such probably was intended to avoid having markets price in a full 50-basis point reduction in September, not to rule out such an option.  With a backdrop of mounting concern about growth, the last thing central bank officials want is to hit markets with a stingier-than-assumed stimulus in September.

One factor that might persuade officials to cut just 25 basis points at first could be the resilience of employment growth, which averaged a better-than-forecast 16.6K per month in June-July.  On the other hand, mortgage finance fell 3.7% in July after declines of 6.9% in June and 4.7% in May, and consumer sentiment slumped to 79.0 in July from 84.7 in June and 89.8 in May.  Symptomatic of the downswing of investor confidence in Australia is the streak of 14 consecutive daily trading days in which the Australian dollar experienced a lower high than on the previous day.



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