Just one week out from the RBA’s next monetary policy announcement, financial markets are pretty much 50:50 in their assessment of whether the cash rate will be raised by another 25 basis points, to 6.5% pa. at 9.30 am Sydney time on Wednesday the 4th of April, following the previous day’s Board meeting.
So how did it all come to this, when as recently as two days before Australia Day an unequivocally benign December quarter CPI triggered a sharp (17 basis point) drop in implied yields on the most actively traded (and it was very active) 90-day bank bill futures contract? And then a further drop of around 10 basis points in the wake of the late February stumble on global equity markets.
Enter into the fray the RBA’s Assistant Governor (Economic) Dr Malcolm Edey’s warning on 16 March that markets had firstly jumped on the ‘sky is about to fall in on the global economy’ bandwagon too readily, followed by a few clinchers like … “inflation is more likely to be too high than too low in the period we can foresee” and … “Information that has become available since that forecast was made suggests that some of the factors pushing up underlying inflation last year remain in place”.
Does all of this mean that the RBA is more likely than not to raise the cash rate again this year? (yes, pretty much, but the balance of probabilities in favour is not overwhelming, by any means) and if so, is the hike likely to happen sooner rather than later? This is the part where fence sitting has become an art form in itself in the last few days.
Above all, monetary policy is all about the RBA’s judgement of the balance of risks to its key forecasts, in this case on the one hand the risk of inflation being allowed to get up too much of a head of steam, versus the risk of another local cash rate increase being implemented just as the sky really does fall in on the global economy.
And what is the risk that the global economy gets derailed at high speed by the crystallisation of one or more of the many risks that overhang its operation, in which case upside inflation risks would be the least of the RBA’s worries?
The tentative track back up in major equity price indices has stalled in the last day or two - the Dow has fallen two nights in a row, while the All Ords has, not surprisingly, taken Wall Street’s lead. But both are not much shy of their recent historical peaks.
So unless a significant shock occurs in coming weeks and months, the global economic backdrop remains conducive to further consolidation of the Australian economy - and consequently does not stand in the way of a cash rate increase if the RBA is so inclined, and it seems that it is.
The foreign exchange market seems to be latching onto the sooner rather than later line with gusto, as evidenced by the rapid run-up in recent days (although it has stopped to draw breath today) in the Australian dollar, not just against a still soft US dollar, but pretty much across the board (the also mulit-year high NZ dollar being a notable exception).
How much of the local currency’s strength would evaporate if the RBA does not move next week? A fair chunk of it, you would think, because widening short-term interest rate differentials between Australia and the US are a key reason for the aussie’s ascent.
Does the Australian dollar’s rise have the capacity to obviate the need for another cash rate increase? Theoretically, yes, because a rising currency does some of the RBA’s work for it - both by making Australia’s exports less competitive on global markets - not that that is an aim of monetary policy - but also by taking some of the sting out of inflation as the prices of imported goods (including oil, of course) fall (or at least do rise as quickly). But these things take time to flow through, and it seems that the RBA does not have that kind of patience just now when it comes to locking in low and stable inflation.
As recently as 2001 - hardly ancient history - the RBA was easing monetary policy even though underlying inflation was rising to what we now know was a cyclical peak of 3¼ per cent (December of that year). But the statements issued by the RBA announcing each of the easings were littered with references to how much spare capacity the Australian economy had to play with at the time. Conversely, recent statements are just as peppered with references to how close that same Australian economy is to a string of capacity constraints.
Moreover, China was a sleeping giant six years ago that is very much awake now. And the RBA seems to think China is enough of an external stimulus to Australia’s economy to offset apparently looming softness in the world’s largest economy as the fallout from the so-called ‘sub-prime’ housing market meltdown percolates through the broader US economy.
But even on that one the RBA hardly seems to be overly concerned … “There has also been some well-publicised distress in the ‘sub-prime’ mortgage market in recent weeks. How far these things might dampen activity is still unclear, and recent indicators have been ambiguous. But at this stage, the overall slowing in the US has been mild, and the housing downturn so far has not caused any major disruption to output and employment in the rest of the economy”. Dr Edey on 16 March again.'