Forex Investment and Currency Trading

Reserve Bank of Australia surprises with 25bp rate cut to 3.00% – likely to pause for a number of months

The Reserve Bank announced a 25 bp cut following it’s overnight Board meeting. For the last month some market analysts have argued that the Bank was likely to keep rates on hold for a number of months to assess the impact of the recent aggressive rate cuts and substantial fiscal stimulus packages which are being implemented by the Government. The other argument in favour of a pause was to allow the Bank to conserve some flexibility to deal with potential further shocks, both domestic and international, over the course of 2009.

In this event the Bank has decided to move again, cutting the overnight cash rate to 3.00%. Market still expect that the rate can eventually fall further to long held target of 2%.

In moving to cut by a further 25 bp’s the Bank has reacted to two significant issues. The first one appears to have been the release of revised world growth forecasts by the OECD which painted a decidedly darker picture of global prospects than had been the Consensus. In this regard, the Statement notes “most assessments of the near-term [global] outlook have been further marked down”.   RBA is unlikely to receive yet further global news to require another global growth downgrade over the next few months, taking some pressure off the need to move on rates again in the near term.

The second significant issue has been a lowering of the domestic growth outlook to formally embrace a recessionary outlook. The Statement notes “The Australian economy is contracting”. Previously the Bank was forecasting flat growth in 2009.

The future path of rates depends on whether you adopt a view that the Bank has decided that the ‘pause’ approach which we saw in March has been jettisoned to get continuous stimulus into the system as early as possible, or whether they still see the attraction of holding back some flexibility to be able to deal with future shocks - either global or domestic.

Some analysts still favour the latter approach and hence expect there will be an extended pause until around August before they see another move, which is likely to be a cut of 50 bp’s. In support of that view, note that the last sentence in the March Statement referring to “The Board will consider the position again at its next meeting”, whereas that sentence has been omitted this time.

A ‘desperate’ RBA may seek other channels of monetary policy, particularly the AUD. Official rates falling below 2% would be likely to see the AUD fall sharply.

The RBA Statement in full:

STATEMENT BY GLENN STEVENS, GOVERNOR
MONETARY POLICY
At its meeting today, the Board decided to lower the cash rate by 25 basis points to 3.0 per cent, effective 8 April 2009.

Recent information from abroad indicates that the contraction in the global economy continued during the first few months of this year, and most assessments of the near-term outlook have been further marked down. Considerable economic policy stimulus is in train in most countries, the full effects of which are not yet discernible, but which should help contain the downturn over the rest of the year. There are tentative signs of stabilization in several countries, including China, though it is too early yet to judge how durable these will prove to be.

Conditions in global financial markets have continued to improve gradually, helped by progress towards a resolution of banking system difficulties in the United States and other major countries. Sentiment remains fragile, however, and the contraction in economic activity is affecting asset quality of financial institutions.

The Australian economy is contracting, though by less than those of its trading partners. Capacity utilization has fallen from its peak, and will decline further over the rest of the year. With demand for labour weakening, growth in labour costs will probably also fall.  Hence inflation over the medium term is likely to be lower than it has been over the past two years. Demand for credit is weak overall, though credit for owner‑occupied housing is picking up.

There has already been a major change in both monetary and fiscal policy in Australia. Market and mortgage rates are at very low levels by historical standards and business loan rates are below recent averages, reducing debt-servicing burdens considerably. Nonetheless, the Board judged that there was scope for a further modest adjustment to the cash rate. The stance of monetary policy, together with the substantial fiscal initiatives, will provide significant support to domestic demand over the period ahead.