The Reserve Bank has given itself some wiggle room on interest rates that it didn’t have last month when it went all hawkish and warned that rates and inflation would remain high until well into 2010.
A combination of strengthening suggestions of a slowdown in Australia and uncertain financial markets conditions in the US, Europe and parts of Asia have allowed the bank to claim this leeway.
This is apparent from a reading of the minutes of the March 4 board meeting which lifted rates 0.25% to 7.25%.
Those minutes (see below) show the bank is no longer as hawkish on the outlook for rates and inflation as it was at the February meeting, and in the first Monetary Policy Statement of the year.
That doesn’t mean it has gone soft, or has lessened its concern. It’s just that the RBA recognises a fair bit has happened since early February.
Even though the slowdown here and the problems internationally have become more apparent since March 4, the bank was obviously concerned enough to inject a milder note into the discussion.
There was no repeat of the February discussion of a 0.50% increase in the cash rate, for instance.
Yes, there was mention of inflation reaching 4%, but that was qualified by the bank suggesting that was lower than previous forecasts because of the substantial tightening in policy already seen.
The change in attitude was shown in a significant change of wording at the end of the decision section of the March 4 minutes where the bank concluded by saying: "They (the board members) judged that the higher setting of the cash rate would leave adequate flexibility to respond as necessary over the months ahead to new information about prospects for economic activity and inflation".
This is different to the concluding comment at the end of the February Minutes: "(The) Board would continue to review whether policy was sufficiently restrictive to return inflation to the 2–3 per cent target within a reasonable period".
No mention of flexibility in the February statement and the phrase "sufficiently restrictive" has disappeared from the latest statement and there’s no talk about returning inflation to the 2%-3% range. Inflation is mentioned generally.
We know the bank thinks inflation will come out at 4% or even a bit more in the Consumer Price Index figures late next month. RBA Governor Glenn Stevens made that very clear in his speech last week to a Federal Treasury seminar. But he did not go on to say this would need some sort of action.
The RBA does acknowledge that, if anything, the outlook for commodities and exports has improved dramatically.
The RBA now expects our terms of trade to have increased by 10% to 15% mid-year from higher prices for commodities like iron ore, coal, wheat, oil and metals. It had previously estimated the improvement at around 5%, perhaps a bit more.
The bank pointed to the ‘substantial’ tightening in monetary conditions in recent months and the rebound in the value of the Australian dollar.
"In judging the appropriate extent of further tightening, members also recognised that developments in financial markets in recent months, both overseas and in Australia, had increased funding costs for intermediaries by more than the effects of past and expected future policy changes.
"Prior to the meeting, 90-day market yields on private paper had reached around 8 per cent, up by about 150 basis points since the middle of 2007. Rates for borrowers from intermediaries were likely to rise by more than any increase in the cash rate, reflecting these higher funding costs.
"Members also noted the possibility of non-price tightening of credit terms, which, if it occurred, would add to the restraint imposed by higher interest rates."
"As a result of this decision and earlier policy adjustments, and rises in borrowing costs that were occurring independently of changes in monetary policy, members saw the overall tightening in financial conditions since the middle of 2007 as substantial."
So it’s against those comments about a substantial tightening that it should be noted there’s been a sharp drop in short term money markets rates over the past week which, if sustained, will take the pressure off banks to further boost their lending rates in excess of any Reserve Bank move.
This drop has been engineered by the RBA keeping the money markets well cashed up and by leaving as much money in its Exchange Settlement Accounts each day as it did in the early days of January when conditions were very tight.
Such have been the size of the falls in yields on 90 and 180 bank bills in the past week that they should obviate the need for any further increase from the banks, even if the RBA doesn’t move.
Yields for 90 day bills Monday were 7.77%, down 0.35% from the peak of 8.12% on March 10, and under the 7.96% on March 4 when the RBA lifted rates 0.25%.
Yields on 180 day bank bills were 7.91% on Monday, compared to 8.25% on March 10 and 8.15% on March 4. That’s a fall of 0.34%. Yields are now at their lowest point for a month.
The amounts left in the ESA have been above $3.5 billion, while the bank has been injecting enough funds each day through its market operations via repurchase deals, to keep the cash rate comfortably at the 7.25% range.
The RBA is still concerned about inflation, the dangers of a wages ‘explosion’ and rising national income and demand. It hasn’t back flipped, but it has now given itself enough flexibility to adjust rates the way it thinks conditions are heading. That means up or down. Up to the March meeting, and perhaps to last week, it was all ‘up’.
