Even though the Reserve Bank of Australia (RBA) left the cash rate unchanged at 3.00% at its February board meeting, the accompanying statement indicated that should domestic demand conditions require, a relatively tame inflation outlook would allow the RBA to lower the cash rate further if needed. At face value, the RBA’s expressed easing bias seems to be at odds with Laminar’s view that there will be no more cash rate cuts. Nevertheless, we are sticking with our cash rate call and we see the RBA’s reminder that it can cut the cash rate if needed (even if never delivered), helping to achieve two important policy aims – confidence among businesses and households that low borrowing interest rates will be around for some time and secondly, a persistent expectation that the cash rate may fall influencing the foreign exchange market to temper the strength of the Australian dollar.
The reasons why we do not see the RBA being in position to actually cut rates further show reasonably clearly in the RBA’s own commentaries over the past week. As the RBA states in the latest quarterly Monetary Policy Statement overseas economic conditions and global financial conditions have improved over recent months and upside and downside risks to the outlook have become more balanced. The Australian economy faces a softer patch in 2013 with the peaking of the resource investment spending boom, consolidation of government spending and a slightly softer employment market, but borrowing interest rates after the cash rate cuts through 2012 are well below long-term average and the full impact of late 2012 rate cuts is too early to judge.
The RBA also mentioned that housing activity and home prices seemed to be improving. Improving housing activity is usually a key leading indicator of a more general lift in household spending and even though the RBA was still quite downbeat about household spending, our view is that the RBA’s caution may be misplaced.
Strong confirmation of rising home prices came with the Q4 house price index showing house prices up by 1.6% in the quarter in eight capital city prices and with a strong 2.3% lift in Sydney home prices. High Sydney house prices have been attracting comment internationally over the past few years, the most recent in an Economist Intelligence Unit commentary on the international cost of living showing Sydney jumping to the third most expensive city position in the world (Melbourne was in fifth position) mostly on extremely high house prices relative to other major cities internationally. Any further cuts in interest rates risk making this relative bubble in Australian house prices worse.
If there were a genuine risk of economic growth tracking persistently below long-term trend, a case might be made for making very accommodating monetary even easier, but that hardly seems the case while the economic outlook in the US and China continue to brighten. The US recovery continues to be built on improving employment (the brightest part of the January services sector ISM report released last week was another sizeable lift in its employment index, up 2.2 points to 57.5 marking the strongest monthly growth since February 2006) and strongly rising household wealth. Chinese growth is improving in all of its major components including, surprisingly, exports, up 25% y-o-y in January.
The bottom line is that we still do not see the RBA cutting the cash rate further, but it may continue to talk as if it has room to cut. Rate cutting talk is all that is likely to be required to encourage households and businesses to borrow with more confidence and to cap the strength of the Australian dollar