Why RBA Cut Deeply In November; And December?

Sydney, Nov 19, 2008 (ABN Newswire) - The Reserve Bank has already given us a couple of surprises with interest rates in the past two months with those bigger than expected cuts on both occasions.

So, after the release of the November 4 meeting's minutes, what are the chances of another surprise next month?

The market now has an 0.50% cut priced in for the December 2 meeting, but there's a chance, once again of 0.75%, according to the futures prices.

The justification this time is the bank will need a cut for January because there's no meeting.

So watch for an 0.50% cut and perhaps a January special meeting?

Rory Robertson of Macquarie Bank reckons that's a more than reasonable bet.

"Almost always, the RBA Board takes a scheduled break in January. Those making judgements about likely policy in December based on the assumption that the Board will not meet again until February, however, might want to think again.

"This year, I'm guessing that the ongoing fragility of the global economy and financial markets - the worst in many decades - will make it hard for the Board to want to take its usual January break. I don't have a story about what it means for policy - if anything - but I'm guessing there's a 50/50 chance the RBA Board will choose to assemble for a "special" meeting in January. "

The November 4 minutes show that for the second month in a row the RBA board decided to boost the recommended interest rate cut by more than the original recommendation.

But in November, there was a small, but important difference.

For the first time in ages, the Reserve Bank was left with a decision to cut rates by one of two amounts: 0.50% or by 0.75%, unlike at the October meeting when the original recommendation was for an 0.50% cut, but Governor Glenn Stevens arrived at the meeting with a new recommendation for a 1% cut after credit and other financial markets went into near meltdown.

The minutes for the Melbourne Cup Day meeting on November 4 make it clear that Governor Stevens and his executives had again recommended a half a per cent cut, subject to review of developments between the preparation of that recommendation and the board meeting

"The paper prepared for the Board recommended a further easing of monetary policy, suggesting a reduction in the cash rate of 50 basis points, with the amount to be subject to review in light of any further information becoming available between the preparation of the paper and the time of the meeting.

"At the meeting, the Governor proposed that members consider the choice between a reduction of 50 basis points and one of 75 basis points".

That was different to what happened in October when the minutes recorded this:

"The paper prepared for the Board recommended a large reduction in the cash rate, of at least 50 basis points, with the amount to be subject to review in light of any events occurring between the preparation of the paper and the time of the meeting. In the event, the recommendation put to the Board at the meeting was for a reduction of 100 basis points, to 6.0 per cent."

And what new information emerged from the end of the previous week, when the board papers were sent to members on November 4? 

The ABS stats on November 3 showing a 1.1% fall in retail sales in September and the house price index for the September quarter fell by 1.8% across the eight capital cities in the survey, which was the sharpest fall for some time. And markets remained nervous, with a credit freeze in place.
So it pays to look at and examine the information flow just before an RBA board meeting in turbulent times. 

That was the same as in October when the volatility in financial markets surged in late September/early October as markets absorbed the impact of the Lehman Brothers collapse and a spate of bailouts in the US and Europe.

The November 4 cut of 0.75%, to 5.25% for the cash rate, took the market by surprise for a second month in a row and has led to conspiracy theories among some market commentators and economists who claimed that it was done deliberately to wrong foot the market and to 'give' a bigger than expected cut

In fact for the second meeting in a row, the board heard that the financial markets had full priced in a cut of 0.50%:

"Members noted that market expectations were for the cash rate to reach 4–4¼ per cent in the first half of 2009. Market pricing indicated that, for the current meeting, a fall of 50 basis points had been fully priced in, with a significant probability of a 75 basis point move."

So the board was left to make the choice by Governor Stevens, which it did by following what the market had been pricing in.

And the justification:

"Members agreed that a further sizeable reduction in official interest rates was appropriate. 

"This would enable a further meaningful reduction in rates paid by borrowers and could assist confidence among consumers and businesses. In addition, given the changing balance of risks, there was an advantage in moving the setting of monetary policy quickly to a neutral position.

"On balance, members judged that a reduction in the cash rate of 75 basis points was appropriate on this occasion. Members were conscious of the high rate of inflation at present and of the need to bring it down over time, but felt that in the current environment a reduction of this size would not undermine that task."

"Key factors in members' consideration of the policy decision were the continuing poor conditions in financial markets, the significant deterioration in the outlook for the world economy, with implications for Australia, and the likelihood that inflation in Australia would fall over the year ahead.

"World financial markets had remained turbulent over the past month. Global equity prices had been volatile and had fallen further in net terms. There had also been very sharp exchange rate movements, including a large depreciation of the Australian dollar.

"The availability of credit in global markets had continued to be tight, though members noted that the measures announced by governments to strengthen their financial systems should help to stabilise conditions over time.

"Data on the world economy indicated a further deterioration in economic conditions in the major industrial economies, and there had been further signs that China and other parts of the developing world were now slowing. 

In Australia, until recently, the overall path of economic activity had been roughly in line with the Board's earlier expectations.

"However, the marked deterioration in global financial conditions over the past couple of months, which had also had an effect on Australian financial markets and share prices, was likely to have a significant effect as well on business and consumer sentiment, and liaison information was reflecting this.

"This would probably lead to a significant curtailment of planned investment spending and caution on the part of households.

"Members judged that the recent reductions in interest rates on loans following earlier policy action, the depreciation of the exchange rate and the fiscal stimulus announced in October would cushion, but probably not fully offset, the negative forces on the domestic economy arising from deteriorating international conditions, lower commodity prices and lower household wealth. 

As such, members thought that domestic spending and activity would be weaker than earlier expected.

"They noted that over the past month the staff forecast for growth had been lowered and that, despite this, the most recent information suggested that the risks to the outlook remained to the downside.

"Members noted that consumer price inflation in Australia was again high in the September quarter, as had been expected.

"However, with domestic capacity pressures now easing and the outlook for much softer growth in demand and activity than had been seen until recently, members could reasonably expect that inflation in Australia would soon start to fall.

"Global disinflationary forces from the slowdown in the world economy and lower commodity prices would assist in this regard.

"The depreciation of the exchange rate, however, meant that the decline of inflation to the target could take longer than previously thought.

"While this could pose risks to inflationary expectations, these were regarded as manageable in the context of a generally disinflationary environment over the next couple of years."


 

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