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Wednesday, 18 March 2015

Further easing may be appropriate

Minutes released

The Reserve Bank Board Minutes are not always the most interesting read, granted, but this month's release was a ripper.

No need for me to regurgitate the entire announcement here, but there were some fascinating parts.

Domestic economic conditions

The case for further rate cuts is made early in the domestic economic conditions section, with Australian GDP growth having continued at a below-trend pace in Q4 2014.

GDP growth in 2014 was 2.5 percent, or just 2.3 percent in trend terms.

Continued growth at this level is deemed unlikely to be strong enough to stem the rise in unemployment.

Further steep declines are also clearly to be expected in mining investment, although non-mining capex (ex-manufacturing) does seem to be steadily responding to lower rates, as denoted by the green line below.

And the headline rate of unemployment has continued to rise gradually to the highest level in well over a decade, with some regional areas being crushed right now.

In the absence of inflationary pressures, then, one would typically expect the cash rate to be cut until unemployment starts falling again, despite the already low level of nominal rates.

The Reserve did note some pick up in employment growth over the past year (in trend terms, yes), while recent retail figures and at least one month's worth of commercial finance data have been somewhat promising.

The objectionable phrase "cautiously optimistic" immediately springs to mind.

However, the Board noted that while house prices were soft in most cities and even declining in others, the housing market in Sydney is strong.

Wading through the rhetoric, the Minutes note a low level of household financial stress, but some concerns as to the potential behaviour of borrowers were interest rates to be cut further. 

"Wait and see"

Throughout the period since August 2013 - when the cash rate was lopped by 25bps to 2.50 percent - the wording of Board Minutes releases has seemingly pointed towards a reluctance to cut interest rates unless necessary, and this continues:

"In considering whether or not to reduce the cash rate further at this meeting, members saw benefit in allowing some time for the structure of interest rates and the economy to adjust to the earlier change. 

They also saw advantages in receiving more data to indicate whether or not the economy was on the previously forecast path."

However, the easing bias remains intact, and further cuts may be deemed appropriate.

"Taking account of all these factors, members judged it appropriate to hold the cash rate steady for the time being, while recognising that further easing over the period ahead may be appropriate to foster sustainable growth in demand while maintaining inflation consistent with the target."

Market expectations

Finally, for what it's worth, markets are still all but pricing in a couple more cuts by the end of the calendar year, which would take the cash rate down to just 1.75 percent.

The wording suggests (to me at least) that the Board would like to wait as long as it can before expending any further ammunition.

The Reserve Bank's "charter" is tripartite, with the first of its trifecta of duties referencing the stability of the currency.

For this reason, the next round of inflation data on 22 April will be keenly anticipated.

The Q4 2014 inflation (Consumer Price Index) figures were a mixed bag with headline inflation very soft and below the lower end of the target 2 to 3 percent range.

However, the underlying inflation measures both came in at 0.7 percent for the quarter despite downward revisions to earlier data.

Perhaps the conservative Board would like to see one more month of CPI data before acting further.