Friday, June 4, 2010

Finally, the Reserve Bank keeps rates steady

• For the first time in four months the Reserve Bank has elected to leave interest rate settings on hold. The cash rate remains at 4.50 per cent.
• It is what left unsaid that stands out in the Reserve Bank’s statement. The statement is surprisingly short and makes no reference to housing prices, consumer spending or the job market. The Reserve Bank Board says that monetary policy settings are “appropriate for the near term”, pointing to an extended stay on the interest rate sidelines.

What does it all mean?
• You can almost hear the collective sigh of relief across Australia. Over 2008 and 2009 Aussie consumers and businesses had to contend with the North Atlantic financial crisis. And as soon as it finished then the Reserve Bank embarked on rapid fire rate increases. The only time that most people have been able to draw breath was at the start of the year. Now there is a second opportunity for Aussies to take stock.
• Aussie consumers and businesses are understandably shell-shocked and now need a little time to adjust to the new financial environment. So the hope is that this time around the pause in rates last longer than one month.
• The Reserve Bank has no doubt been surprised at the extent of caution exercised by consumers. Surveys have regularly suggested that confidence levels are high, but the evidence at cash registers shows that people aren’t putting the money where their mouth is. Still, when faced with an aggressive Reserve Bank, it’s clear that the caution is justified.
• Interestingly economists have a cash rate of around 5.00-5.25 per cent priced in by end year but financial markets are less sure, tipping rates won’t move over the next six months. As always it will depend on how inflationary pressures track over the remainder of 2010. But given that retailers are actively discounting rather than putting prices up, inflation doesn’t appear set to soar any time soon.
• CommSec believes that the economy will lift later in the year, meaning borrowers should factor in rate increases of up to half a percent. But in the current environment this appears more of an upside risk. As we have seen over the past two months, the environment can effectively turn on a dime. The optimism that was in abundance in mid April has now given way to fear and uncertainty with investment markets increasingly skittish.
• The shift in views in recent months is clearly in evidence in the bond market with yields on three-year government paper falling around 75 basis points (or three-quarters of a percent) in just the past month.
Interest rate decision and past cycles

• The Reserve Bank Board has left interest rates on hold for the first time in four months, leaving the cash rate at 4.50 per cent. In October 2009 cash rates stood at a 49-year low of 3.00 per cent. But then the RBA embarked on a process to remove the emergency stimulus, lifting the cash rate by a quarter of a percent in October, November and December 2009, and then in March, April and May 2010.
• In the last rate-cutting cycle the cash rate fell to lows of 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
• But given that banks have been forced to lift rates above the cash rate, the Reserve Bank has looked more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.40 per cent, above the long-term average or “normal” rate of 7.15 per cent.
• The Reserve Bank says: “Taking all the available information into account, the Board views this setting of monetary policy as appropriate for the near term.”
What are the implications of today’s decision?
• The $64 million question is how long will interest rate settings remain on hold? Clearly consumers and businesses would love some assurances. Unfortunately that’s not possible – even the Reserve Bank would be hard-pressed making sense of the volatile environment. But certainly people need some sense of the interest rate trajectory so that they can plan and generally get on with business.
• The six-month overnight indexed swap rate is as good as any indicator in providing views on the interest rate outlook. And at present the pricing points to no change in cash rates until much later in the year.
• Housing and retail-focussed businesses have most to celebrate in today’s ‘on hold’ decision by the Reserve Bank – especially retailers of discretionary, non-essential or luxury goods.
• Looking ahead, it is clear that the Reserve Bank has sole responsibility for keeping the economy on the straight and narrow. The Federal Budget confirmed that fiscal policy isn’t playing an active role at present with the ‘automatic stabilisers’ relied upon to improve the budget bottom line as opposed to discretionary spending cuts or tax increases by the Government. So if the economy picks up pace, the focus will again switch to rate hikes.
• The modest size of the accompanying statement from the Reserve Bank almost suggests that Board members had to leave the meeting in a hurry. We are now effectively in the dark about its views on the economy given that most of the statement focussed on Europe, not Australia.

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