Reserve Bank and Interest Payments

RBA Board minutes; Reserve Bank patiently sits on the sidelines report

• Reserve Bank Board members agreed on “a wait and see” policy at the last interest rate meeting, noting the significant improvement in economic conditions in domestic and global economies and allowing market interest rates to price in rate hikes.
• There are two key factors holding the Reserve Bank from raising interest rates. The bank is still unsure about the sustainability of the recovery and is also concerned about the health of business balance sheets.
• Board members noted the “strong macro stimulus” and the strength in the Asian region has provided a considerable support to the Australian economy adding to concerns over the already relatively high levels of underlying inflation.
• Australia’s chief commodity forecaster, ABARE, expects Australian winter crop production to have increased by 3.4 per cent to 36 million tonnes. Forecasts for Australia’s 2009/10 wheat crop is expected to rise by 3.4 per cent to 22.7Mt.

What does it all mean?
• It is pretty clear from the minutes of the latest Reserve Bank Board meeting that the Board believes that the best approach is to hold off on any rate hikes until more concrete economic data is available in coming months. The Reserve Bank Board has confirmed that the Australian economy is on a recovery path with the “strong macro stimulus” and the strength in the Asian region supporting the Australian economy.

The Reserve Bank Board is in “wait and see mode” on interest rates. Board members are still not convinced that the economy can stand on its own two feet. The Board also believes that further repair work is necessary on bank and private company balance sheets. However a quiet confidence is perceived in the Board minutes with members noting that domestic economic conditions continued to evolve in line with bank forecasts. And as the risks to the global and domestic economy diminish, the board will no doubt become more relaxed about raising interest rates.

In particular members focused on the strength in the Asian economies in particular China. The pickup in car sales in China and increasing export volumes throughout the Asian region bodes well for the longer term fundamentals for the Australian economy. Importantly Board members believed that the Chinese economy would continue to record solid growth outcomes in the longer term.

•The Board clearly believed that with interest rates at 49 years lows and significant fiscal stimulus currently been undertaken, it was having an expansionary effect on the Australian economy. However with fiscal stimulus waning, the Board is likely to keep the monetary stimulus in place until the recovery gets a strong foothold. As a result the Reserve Bank decided the more prudent course was to keep rates on hold at the last meeting.
• Certainly the relatively high underlying measures of inflation, coupled with the stronger level of domestic economic activity will be a key concern going forward, and the likely barometer for the timing of rate hikes. The Board noted that the rise in market interest rates had effectively done part of its job already, adding to the borrowing costs for business and mortgage holders and restraining the momentum of the economy.
• At this stage the Reserve Bank looks likely to keep rates on hold in upcoming months. However CommSec is not ruling out the possibility of the first rate hike of 25 basis points taking place in December.
• The rural sector certainly did its part in ensuring that the Australian economy avoided a recession and will play a significant part in supporting the economy until the recovery gains a strong foothold. ABARE has revised up forecasts for Australia’s winter crop production by 3.4 per cent to 36 million tonnes.
• The one major risk to forecasts is the possibility of not enough healthy rain, especially in Queensland and Northern NSW. Already the lack of winter rains has had a critical effect on crop production. However improvement in weather patterns in Western Australia has helped to support the upgraded crop estimates. The combination of higher production, favourable prices will be offset by a stronger Australian dollar.

What do the figures show?
• The Australian Bureau of Agricultural and Resource Economics (ABARE) expects Australian winter crop production to have increased by 3.4 per cent to 36 million tonnes on a year ago.
• Forecasts for Australia’s 2009/10 wheat crop are expected to rise by 3.4 per cent to 22.7Mt. ABARE did note that the winter rainfall was below average in Queensland and Northern NSW, however widespread rainfall over the first week of Spring has provided a degree of improvement for crop production However further good rain is needed. Western Australian crop production is expected to fare better above average spring rainfall expected.
• Barley production is tipped to rise from 7.7Mt over 2009-10 to 7.9Mt. Canola crop production is estimated to hold steady at 1.7 million tonnes in 2009-10. Sorghum production will fall 4.6pct in the year to 1.85 million tonnes, while cotton seed production will fall 12 per cent to 531,000 tons in 2010.
Minutes from the May Reserve Bank Board meeting
Key Comments:
• “Members were briefed on the recent data for the Chinese economy, which had been somewhat mixed. Car sales had risen very sharply and export volumes had also been growing, including recently to the United States and Europe.”… “Overall, members observed that some slowing in the Chinese economy relative to the rapid pace in the June quarter had been inevitable but that the longer-term prospects were strong”
• “Of most significance to Australia, the Asian region had recorded strong growth in the June quarter. While this had been largely driven by domestic demand in these economies, reflecting strong economic stimulus, there were also recent signs of a pick-up in their exports...”
• “Outside Asia, most economies had experienced another fall in GDP in the June quarter, though more recent information suggested that the majority of these economies were now approaching a turning point.”
• “The US economy was expected to grow in the September quarter, after contracting by 4 per cent over the previous year”
• “In relation to housing markets, members observed that in countries that had experienced better economic outcomes and/or fewer financial sector problems (e.g. China, Canada, Norway and Australia), house prices now appeared to be rising quite solidly and were above or around earlier peaks. Even in the US and UK, which had earlier experienced significant falls in house prices, there had been some up-ticks recently”
• Retail sales: “Measures of sentiment had continued to strengthen. Consumer sentiment had risen sharply over the three months to August. Liaison with retailers suggested that household spending had softened somewhat in July but had been better in August.”
• Business investment: “The data for business investment in the June quarter indicated a strong rise in spending on plant and equipment, with a sharp increase in spending on a wide range of capital goods, including cars. However, this mostly reflected the bringing forward of spending to qualify for tax allowances. Car sales had subsequently fallen in July.”
• Exports: “The data for June quarter export volumes showed most categories were growing or holding up reasonably well. Manufacturing exports were the exception, and had fallen broadly in line with the falls seen in many other countries. On average, commodity prices had been broadly steady since the last meeting.”
• Financial markets: “There were some favourable signs in the Australian residential mortgage-backed securities market. The gap between secondary market yields and primary market yields was continuing to close, such that the prospect of issuance without the support of the Australian Office of Financial Management was increasing.”
• “Turning to banks’ funding, members noted that there had been a continuation of the strong competition for deposits. Together with an increase in term interest rates, which were rising because of expectations of monetary tightening, this was contributing to an increase in bank funding costs.”
• Outlook: “An important question for members was whether the global economic improvement would be sustained, or whether it was mainly a reflection of the strong macroeconomic stimulus that had been applied over the past year and might in due course fade. Members were also conscious that, even though financial market conditions had improved significantly and debt markets were beginning to function again, banks, corporates and households in many countries still faced significant balance sheet adjustments.”
• Policy decision: “As at the previous meeting, members noted that the policy decision in the near term involved balancing the risk of over staying an accommodative stance, and that of prematurely tightening and adversely affecting confidence and demand. The meeting concluded that the balance was best struck by leaving the cash rate unchanged for the time being, pending further evaluation of incoming information at future meetings.”

What is the importance of the economic data?
• The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.
• The Australian Bureau of Agricultural and Resource Economics (ABARE) release its Crop Report each quarter. The latest estimates on winter and summer crops assists investors in assessing conditions for the rural and resources sector and companies leveraged to these industries
What are the implications for interest rates and investors?
• CommSec is pencilling in the first rate hike within the first quarter of 2010. With longer term interest rates and funding costs for banks rising the Reserve Bank is more likely to hold of on any rate hikes and allow the market to price in higher cash rates.
• However if the domestic economy continues along the current recovery path a rate hike in December cannot be ruled out.

Source Savanth Sebastian, Economist, CommSec