Newsletter Century 21 ANZ Economic Update

 RBA CUTS RATES TO 4.25%. A FURTHER MODEST EASING IN PROSPECT NEXT YEAR

·  RBA cut its official cash rate by 25bps to 4.25%. 

· ANZ now expects the RBA will cut its cash rate by a further 25bps, to 4.0%, at the February 2012 Board meeting (the RBA Board does not meet in January).  With global risks likely to remain heightened (and still potentially worsen), the Australian price pressures well contained, and domestic unemployment still likely to head higher, we see little risk that domestic inflation will be ignited by the further boost to growth afforded by another modest monetary policy easing.

· Whilst financial markets continue to price the cash rate to fall below 3.0%, we consider a lot still has to go wrong before the RBA will slash interest rates to such emergency levels.  That said, a failure to deliver meaningful policy progress at this week's European leaders’ meeting would certainly increase this risk.

· The decision to cut today was based on the deteriorating global environment, with the RBA now warning that "the likelihood of a further material slowing in global growth has increased".  The RBA is now particularly concerned that the troubles in Europe are spreading to Asia via a slowdown in trade, and also warn that global financing conditions have become "much more difficult", especially in Europe.

· Interestingly, the RBA does not (yet) appear to judge the recent slowing in China as unexpected, suggesting instead that "China's growth has been slowing, as policymakers there had intended".  Nevertheless, given the above, we can presume that the balance of risks to the RBA's view on China (and thus on Australian commodity prices) has shifted to the downside.     

· Whilst not explicitly acknowledging this, the RBA must now see downside risks to its domestic economic forecasts.  Whilst the Board sees Australian economic growth as remaining close to trend at present, it does highlights the now more difficult term funding conditions for financial institutions (which, if persistent, risk a de-facto tightening of domestic financial conditions), as well as the recent further decline in asset prices (which are undermining confidence, and balance sheets). 

· The RBA confirms domestic inflation is no longer a theat, and is thus likely to be consistent with the 2-3% target in 2012-2013 (abstracting from the carbon tax).  This is consistent with our own forecasts, and indeed we have previously warned that underlying inflation could ease further to just 2¼% y/y by mid-2012.  

· The statement does not indicate whether today's 25bps easing has shifted monetary policy to an explicitly 'easy' stance.  We suspect the Bank judges the new level of the cash rate as still consistent with a broadly neutral policy setting, given that it will push lending rates only slightly below their average level of the past 15 years.  Set this against the still high level of the A$, weak asset prices, soft credit growth and potentially tighter credit conditions (at least offshore) and it could even be argued that after today's rate cut, financial conditions in Australia still remain a little tight. 

· This keeps a further modest easing in policy in prospect, particularly if global risks fail to improve.  Going forward, the Board will likely continue to ask itself at each meeting whether the Australian economy can grow a little faster without threatening its inflation target.  Given the current balance of risks, we expect the answer to this question will remain 'yes' in early-2012.

· A full copy of today's Statement is reprinted below.

Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 4.25 per cent, effective 7 December 2011.

Growth in the global economy has moderated this year after a strong performance in 2010. Some of the slowing reflected temporary factors, and as these passed, the pace of expansion in the United States and much of Asia began to pick up around mid year. China's growth has been slowing, as policymakers there had intended. Trade in Asia is now, however, seeing some effects of a significant slowing in economic activity in Europe.

The sovereign credit and banking problems in Europe, to which European governments are still seeking to craft a full response, are likely to weigh on economic activity there over the period ahead. Financial markets have experienced considerable turbulence, and financing conditions have become much more difficult, especially in Europe. This, together with precautionary behaviour by firms and households, means that the likelihood of a further material slowing in global growth has increased. Commodity prices have reflected this, declining further over recent months and taking pressure off CPI inflation rates. This has increased the scope for some easing in monetary policy in a number of countries.

Information about the Australian economy suggests output growth has been close to trend, with demand growth stronger than that. The terms of trade have now peaked and will decline somewhat in the near term, but they remain very high. In response, investment in the resources sector is picking up very strongly, with much more to come. Some related service sectors are enjoying better-than-average conditions. In other sectors, changed behaviour by households and the high exchange rate have had a noticeable dampening effect. The unemployment rate has increased a little since mid year, though it remains close to 5 per cent.

CPI inflation on a year-ended basis remained above the target at the latest reading, due to the effects of weather events last summer, but is now starting to decline as production of key crops recovers. Moreover, with labour market conditions now softer, the likelihood of a significant acceleration in labour costs outside the resources and related sectors in the near term has lessened. Accordingly, the Bank's current judgement is that inflation is likely to be consistent with the 2–3 per cent target in 2012 and 2013, abstracting from the impact of the carbon pricing scheme.

The reduction in the cash rate as a result of the Board's previous decision flowed through to lending rates, which are now around their average level of the past 15 years. Short-term market interest rates have tended to decline a little further in recent weeks, though term funding conditions for financial institutions have become more difficult. Credit growth remains subdued and asset prices have declined further over recent months. The exchange rate has been quite variable over the past few months, but remains at an historically high level.

Overall, the Board concluded, on the basis of all the available information, that the inflation outlook afforded scope for a modest reduction in the cash rate. The Board will continue to set policy as needed to foster sustainable growth and low inflation over time.

http://www.rba.gov.au/media-releases/2011/mr-11-28.html