The Minutes of Reserve Bank’s May 7 meeting that produced the surprise cut in interest rates make clear that the high value of the dollar had nothing to do with the decision – despite reports in the media and from business economists to the contrary.
In fact the minutes (http://www.rba.gov.au/monetary-policy/rba-board-minutes/2013/07052013.html) go further to make it clear that the board cut rates to support what is expected to be soft demand in the economy through the rest of the year. Currency wars had nothing to do with it – the dollar’s high value was mentioned only in passing.
The key part of the minutes – the section entitled "Considerations for Monetary Policy", makes clear the RBA’s worries that domestic demand was starting to look too soft for comfort. There are several mentions throughout the minutes that growth being "below trend" and "somewhat below trend" – RBA code for ‘that’s a bit of a surprise and we worried’.
"For some months the Board had considered that the inflation outlook provided scope to ease monetary policy further, should that be necessary to support demand. Members recognised that the effects of the earlier reductions in interest rates were still working through the economy.
"Nonetheless, growth was expected to be somewhat below trend for a while, and the inflation outlook had, if anything, been revised down slightly. Members were conscious of the strengthening conditions in the housing market, but also noted that, thus far, credit growth had remained subdued.
"Taking all the factors into consideration, the Board decided that some of the scope to ease policy should be used at this meeting. It judged that a further reduction in the cash rate was appropriate to encourage sustainable growth in the economy, consistent with achieving the inflation target."
That the Aussie dollar has sunk by around 5c since the RBA meeting tells us nothing because much of that is down to the strength of the US dollar and the weakness of the yen.
And the minutes told us nothing as to whether further rate cuts might happen. If anything, the likelihood of further rate cuts has been reduced by the fall in the value of the dollar which traded around 98 US cents for much of yesterday and overnight.
While the RBA remains concerned about softening demand later in the year, for now it’s sticking to a cautious short term outlook.
"Growth in economic activity was still expected to be a little below trend this year, picking up gradually to be close to trend through 2014.
"The near-term forecast reflected the slowing in overall business investment, given the peak in the mining investment boom along with the effects of fiscal consolidation and the high level of the exchange rate.
"This was expected to be partly offset by growth of resources exports, a pick-up in consumption and moderate growth in dwelling investment."
The rate cut was to make sure this outlook survives into 2014 and doesn’t go off the rails.
The success we have had in controlling inflation allowed the RBA to cut the cash rate in the knowledge this wouldn’t add to inflation over the next year or so.
Now, with the dollar under parity and possibly going lower, expect the central bank to sit on its hands for a few months to see what transpires.
But it does have some ammunition left because in the statement it says it had decided to "use some of this scope" to cut rates created by the lower than expected inflation.
