As expected by FIIG, and most financial market forecasters, the RBA statement yesterday indicated that the cash rate was to be cut 25bps to 3.00%
While expectations of an imminent rate cut were realised, we now expect more easing to occur over the latter part of 2013, assuming no dramatic developments in offshore markets in the short term. At the end of 2013, we expect the cash rate to be around 2.50%. Specifically, scope for even more easing, than currently expected, even below 2.50%, might emanate from global developments, especially in Europe, where risks remain significant yet very difficult to predict.
Despite this current easing, the yields on term deposits and longer term debt remain attractive, especially given that corporate debt is returning more than double the government rate in most cases.
Statement
The following points are evident from the statement:
- Global growth comments were largely similar to the prior period:
“Global growth is forecast to be a little below average for a time. Risks to the outlook are still seen to be on the downside, largely as a result of the situation in Europe, though the uncertainty over the course of US fiscal policy is also weighing on sentiment at present. Recent data suggests that the US economy is recording moderate growth and that growth in China has stabilised. Around Asia generally, growth has been dampened by the more moderate Chinese expansion and the weakness in Europe.”
- In general, the assessment of financial market developments was largely unchanged from the prior statement. As the RBA indicated,
“Sentiment in financial markets remains better than it was in mid year, in response to signs of progress in addressing Europe's financial problems, though Europe is likely to remain a source of instability for some time”
- In general, the RBA summarised domestic conditions by noting that growth “has been running close to trend”. The statement yesterday, similar to the last one, highlights that capital expenditure is driving this, however the weakening of conditions in some other sectors is now noted. The prior comments suggested the peak of the resources boom is likely in 2013, while this statement suggests new data “confirms” that the peak is approaching. The RBA noted that private consumption is expected to grow. They also stated that “there are indications of a prospective improvement in dwelling investment, with dwelling prices moving a little higher, rental yields increasing and building approvals having turned up”
- On inflation, the RBA repeated most of what it said last month. The RBA continue to emphasise that even further improvements in productivity are needed, so as to offset the “waning” impact of the higher currency on inflation
- The RBA again stated the signs of easing conditions continue to be observed, however the full effects of earlier measures are yet to be felt. Regardless, the move yesterday was deemed “appropriate now” and “will help to foster sustainable growth in demand and inflation outcomes consistent with the target over time”
Other factors
Markets are now correcting somewhat exuberant expectations, which were generated with the long awaited QE3. However, the recent earnings season, combined with a more serious wrangle in the US over fiscal issues, are gradually bringing the equity market back to a more realistic position, meaning equity prices have further downside. Gradually, the US bond market is now delivering what the Fed wants, the provision of lower longer term interest rates. A target of 1.25% on the US 10 year is feasible, and with a possible spread of 1.25% to the AUD 10 year, there is still plenty of room for the Australian 10 year bond to rally from 3%.
Conclusion
As we observed with the recent RBA minutes, financial market commentators are quick to overstate changes in RBA rhetoric; they have a habit of “jumping at shadows”. We have tried to avoid this habit with our estimations, which have remained somewhat consistent over time. What had driven our assessment towards an easing yesterday was partly a gradual decline of demand in the labour market, and party the decline in the mining sector, which are issues that the RBA has recently highlighted. We now think that a pause in rate cuts is something that the RBA will seriously consider, before easing further over 2013. However, Europe remains the key risk for the RBA and for expectations of economic growth.