RBA rate cut?
Tuesday, 5 August 2008 9:20am
The Reserve Bank of Australia (RBA) meets today to assess the country's monetary policy settings.
Financial markets remain convinced that the RBA will hold rates at a 12-year high of 7.25 percent after its meeting today. However, recent data showing that domestic economic conditions are deteriorating have prompted some to speculate that an interest rate cut is imminent. It appears that markets have already discounted the 4.5 percent CPI reading and instead are focused on more recent releases showing a contraction in retail sales, slowing private sector credit, falling consumer and business confidence and a decline in housing.
Futures market pricing now indicates a 25-30 percent chance that the RBA will cut interest rates before the year is over. Once again, this indicates the markets' fickleness especially considering that just a month ago, after the shock CPI reading, markets were factoring in a rate HIKE over the next 12 months.
While we agree that domestic interest rates will eventually come down, this is not yet the time. Surely, there are emerging signs that the economy is losing momentum but given the boost to national income from our rising terms of trade, worries that it could slump into a recession are exaggerated. In addition, inflation remains 1.5 percent above the RBA's upper limit. Yes, the RBA targets medium term inflation but who could be certain what inflation would be in the medium term? Inflation in the US remains above target despite its economy verging on the cusp of a recession.
Unfortunately this time, inflationary pressures are coming from without, in the form of strong commodity demand from industrialising nations like China, India, Russia and oil exporting countries who have tonnes of cash to spend. It will be hard to rein in inflation until demand from these economies slow.
On this, there is some good news with commodity prices falling sharply overnight. The CRB index dropped by 3.4 percent with the price of crude oil down by 3.2 percent to US$121.10, after hitting an intra-day low of US$119.51 a barrel.
Major world central banks will have an easy task on their hands if this trend towards lower commodity prices continues as they could then focus on providing the dynamics to lift growth. However, the balance of probabilities remains for elevated prices for some time to come.
We do not expect the RBA to lower interest rates while inflation remains a real threat.
The US Federal Reserve meets tomorrow night to conduct its own monetary policy assessment, followed by the Bank of England and the European Central Bank meetings on Friday.
Benjamin Ong
