n     The RBA left the cash rate unchanged at 4¼% after the February Board meeting.

n     A very clear easing bias is in place.

n     But a clearer threat to an otherwise favourable economic backdrop needs to emerge before the RBA acts on that bias.

There was near‑universal agreement amongst economists for a rate cut today.  Financial markets had priced in a very high probability of a move as well.  In the event, the RBA surprised by sitting on the sidelines.  The cash rate remains at 4¼%. 

Perceived downside growth risks towards the end of 2011 encouraged a shift in policy preference for more neutral settings.  Low inflation readings (actual and prospective) allowed policy action.  The advantage of staring from neutral is that the transmission of a more aggressive easing stance through to the economy, if needed, will be quicker given the more advanced starting point. 

But global developments since the last RBA Board meeting in December have allayed some of those earlier RBA fears.  The US looks a little healthier, China remains robust and some progress is evident in Europe.  Commodity prices have retraced part of recent losses and financial markets are a little friendlier. 

The domestic story is little changed.  The economy is growing close to trend and inflation is expected to track within the RBA’s 2‑3% target range.

The rates “guidance” in today’s Statement, however, is very clear.  Risks in Europe are still skewed to the downside.  There are “differences” between domestic sectors.  So if “demand conditions weaken materially” there is “scope” for easier monetary policy. 

Financial markets will continue to price in further rate cuts and the debate between economic commentators will lean in that direction as well.  The terminal cash rate will depend mainly on how the European story evolves.  While that story is evolving the need for lower rates will be debated at every RBA meeting.  But a trigger is required.  There are plenty of potential flashpoints.  Significant quantities of Italian, Spanish, Portuguese and Greek debt are due to mature over the February‑April period.  Negotiations over Greek debt and a second bailout package need to be finalised soon.

These events are risks and not part of baseline forecasts.  As a result, we have pushed back the timing of the next move to May when we have a 4% cash rate pencilled in.  The risks lie with an earlier move. 

The next monetary policy signpost is the quarterly Statement on Monetary Policy (SMP) on Friday.  We expect the SMP to highlight the competing pressures on monetary policy.  The SMP should confirm that inflation is a non‑issue in the near term.  The QIV underlying CPI was in line with RBA forecasts back in November.  The February forecasts should continue to show core inflation tracking within the 2‑3% target range during 2012.  Headline inflation may be revised a touch lower.

But upside inflation risks remain over the medium term.  The terms‑of‑trade, for example, is at elevated levels and the mining capex boom rolls on.  The accompanying income and spending stimulus is hitting an economy that on some measures is close to full capacity. 

So current RBA forecasts showing underlying inflation picking up into the upper half of the 2‑3% target range by 2013 should also remain in place.  The RBA only gives a forecast range for end 2013.  But the fact that the upper end of that range is “3” should be seen as an indication of the direction of risk.

We suspect that RBA growth forecasts will also be left largely intact.  The QIII GDP numbers were actually a touch above that implied in the RBA’s November projections.  Global growth forecasts by bodies such as the IMF are now lower.  But these recent revisions have really only caught up with RBA thinking at the end of last year. The terms‑of‑trade probably fell in QIV.  But a decline is already incorporated into RBA forecasts.

Even if growth forecasts are left unchanged, the composition of that growth is worth a close look.  Much of the policy thinking in 2010/11 reflected a desire to get households a bit more focused on savings and paying off debt and a bit more cautious about spending.  Increased household savings, for example, has helped absorb the inflation pressures from the mining boom.  Any indication in the forecasts of rising consumer activity will be an indication of limited downside for interest rates.

The above article was provided by:
Commonwealth Securities Limited
Economics Research Level 24, Darling Park Tower 1, 201
Sussex Street, Sydney, NSW 1215 Australia