Monday night, the Reserve Bank of Australia (RBA) released its minutes for its October 2nd meeting where it cut interest rates 25 basis points to 3.25%. I was looking for a more detailed justification of the rate cut since I had not expected the RBA to cut just yet, and I also did not think a rate cut would help the Australian economy at this juncture. Here is how the RBA explained its decision in the monetary policy statement on October 2nd:
At today's meeting, the Board judged that, on the back of international developments, the growth outlook for next year looked a little weaker, while inflation was expected to be consistent with the target. The Board therefore decided that it was appropriate for the stance of monetary policy to be a little more accommodative.
The RBA seemed to base its decision more on external developments than internal ones. So in the minutes I expected to read about how external economic stresses would translate into economic stresses in Australia. For example, a slower growing China produces lower commodity prices which then reduces incomes in Australia, etc.. Instead, the RBA noted that "members agreed that it was too soon to see much, if any, of the effects of recent developments in bulk commodity markets on domestic economic activity." The RBA summed up its rate-cutting logic as follows:
At its previous meeting, the Board had observed that the effects of earlier reductions in the cash rate were still working through the domestic economy, and that the outlook for inflation was consistent with the target over the next one to two years. Members concluded that the current assessment of the inflation outlook provided scope to adjust policy in response to the softer growth outlook. Therefore, at this meeting the Board judged that it was appropriate for the stance of monetary policy to be a little more accommodative, thereby providing some additional support to demand over the period ahead.
The RBA almost seems to be saying that it is willing to tolerate a little higher inflation than target in order to provide a pro-active cushion for domestic demand. The RBA has consistently observed that the impact from earlier rate cuts are still working their way through the economy - "it was too early to see the full effects of earlier reductions in interest rates" - so an additional rate cut in the face of on-target inflation strongly suggests the RBA is attempting to move well ahead of any deep trouble. The RBA says nothing about the risks of recession, only that growth might be "softer."
What IS certainly clear from the minutes is that the RBA notably downgraded its assessment of the commodity-driven portion of the economy while at the same time projecting a soft landing.
…the forecast profile for mining investment might not be quite as strong as previously expected. Overall, resource investment could peak earlier, and at a lower level, than had previously been forecast…the lower peak could be associated with a more gradual decline subsequently, and resource investment as a share of GDP would likely remain at a high level for several years…members noted that there had been a noticeable decline in the appetite for spending by Australian companies in some parts of the resources sector…While there remained considerable uncertainty about the outlook, the lower resource investment profile suggested growth in demand and output over the coming year could be below previous forecasts…
The RBA's commentary on the non-mining sectors expressed no alarms, certainly nothing that, under normal circumstances, would suggest yet another rate cut would help. The weakest portion of the non-mining economy appears to be construction although sentiment in the housing market has improved:
Softer demand for labour had been particularly pronounced in the construction industry, with employment there falling from relatively high levels. In addition, mining employment had recorded a modest decline in recent months for the first time since the middle of 2009…
Dwelling investment remained at a low level in the June quarter, although there were signs of improving sentiment in the housing market more recently. Members noted that weak dwelling investment had been at odds with the fundamentals for housing demand, as evidenced by the relatively low vacancy rate, below-average mortgage rates and ongoing population growth…
The improvement in sentiment in the housing market had been accompanied by an increase in dwelling prices in recent months.
While the RBA continues to fear that Europe's sovereign debt crisis is "…likely to present large downside risks to the world economy for some time," the RBA also noted no significant stresses in financial markets.
So, overall, I did not get the sense of urgency that I would expect for a central bank that has decided to restart a rate-cutting process. In fact, if it were not for the following statement, I would conclude yet again that the RBA is not likely to cut rates again anytime soon:
In the money market, current market pricing implied a significant probability of a 25 basis point easing in monetary policy at this meeting. Thereafter, pricing had the cash rate falling to around 2½ per cent by the middle of 2013.
Of all the borderline reasons the RBA provided for dropping rates again, "the market told me to do it" appears the most convincing to me. I am also assuming that the RBA thinks moving toward those low rates will finally pressure the Australian dollar (FXA) lower. Given the Australian dollar's relative resilience, especially in the face of aggressively accomodative monetary policies at other central banks, it will take 2% to shake interest in the Aussie. After the Federal Reserve's QE3 announcement in mid-September, the U.S. dollar has actually gotten stronger against the Aussie. However, for the last two weeks, the Australian dollar seems to have stabilized around support represented by the 2010 and 2011 closing levels.
The Australian dollar remains resilient against the U.S. dollar
Be careful out there!
Additional disclosure: In forex, I am roughly net neutral on the Australian dollar: short AUD/USD, short EUR/AUD, short GBP/AUD