Forex Investment and Currency Trading

The RBA kept the cash rate target at 7.25% at the April Board meeting. 

Key Quotes

 ·         “The Australian economy grew strongly through 2007…However, other recent information provides tentative evidence that growth in domestic spending is moderating”.·         “Sentiment in global financial markets remains quite fragile and Australian financial intermediaries are experiencing increases in funding costs, which are being passed on to borrowers”.·         “As a result of the recent monetary policy decisions and rises in borrowing costs that are occurring independently of changes in the cash rate, the overall tightening in financial conditions since the middle of 2007 has been substantial”.·         “That is working to foster the moderation in demand growth that will take pressure off inflation”.·         “In the short term, inflation is likely to remain relatively high, and both the CPI and underlying measures will probably rise further in year-ended terms in the March quarter. However, inflation should decline over time, provided demand slows as expected”. 

Analysis

 There was no real doubt that the RBA would keep the cash rate target steady at 7.25% at the April Board meeting. There had been no smoking gun since the last meeting. Apart from a higher employment reading, the activity data had generally underperformed expectations, particularly with respect to household expenditure. In addition, financial market conditions had tightened further with three more major banks (NAB, Westpac and ST George) raising lending rates independently of the RBA. Unofficial retail bank tightening is now likely to have added 30 to 35 basis points to what the RBA have already delivered. For the statement that accompanied the rate announcement, it was more balanced than the mildly hawkish one that accompanied the March rate hike. More acknowledgement was given to the downside growth risks rather than the upside inflation risks with the Bank pointing to activity data that is likely to signal a softer demand environment in the future. In addition, gone was the reference to the tight labour market that was present in the March Statement. Instead, there was another reminder that while inflation would be higher in the short-term, it should decline over time. The RBA did continue to warn of further rises in the terms of trade though. This is most likely to come from bulk commodity contract negotiations scheduled for this quarter, but whether this is likely to offset the headwinds confronting consumers is another matter. 

Implications

 The current cash rate should mark the peak in the current cycle. Demand growth is likely to ease as financial conditions tighten further, particularly as households start to de-leverage and as banks seek to further narrow the gap between the cost of wholesale borrowing and their retail lending rates. The forces that will moderate domestic demand growth will set the conditions for a lagged easing in inflation in 2009. 

To be sure, the upcoming CPI result remains a risk for the May Board meeting. But the RBA has for two months now warned that yearly inflation would be higher for the March quarter. Based on these comments the hurdle rate for inflation to provoke another rate rise should be very high. In all likelihood, higher inflation expectations were loaded into the two previous rate rises. As such, RBA expectations for a 4.0% yearly inflation result should provide little to no new policy value. Market sees the economy slowing such that the next movement in interest rates will be a cut. GDP growth is likely to slow by enough to eliminate the output gap from Q308, which will open the door to the next stage of the policy cycle.