Go back just two weeks and around 80% of the market was predicting a 25 bps rate cut from the RBA this Tuesday, now it’s looking like a 50/50 call. Considering the mixed economic data out of Australia of late, varied signals from abroad and the lack of clear direction from the RBA, it is not hard to see why investors are so unsure about the future of monetary policy in the near-term. The situation is further complicated by varied indicators from abroad.
Last time around, the board was more dovish than the market expected, causing investors to jump to the conclusion that the RBA would loosen policy again this month. Looking over the meeting minutes and, in particular, the statement made by governor Stevens, it appears the bank was justifying its decision to trim the cash rate then, as opposed to suggesting another rate cut was on its way. Also, whilst the statement was overly dovish, it wasn’t bleak enough to result in a 50 bps cut, something we would expect from the bank if it was the emergency situation the market seemed to be suggesting post-cut, at least until the release of Q3 inflation data.
Also, there were a few key triggers for the October rate cut that don’t still hold true, or at least haven’t deteriorated. Namely, we have seen a turnaround in sentiment regarding the Chinese slowdown, sparked by better than expected export data, industrial production figures and a pick-up in sentiment in the heart of the Chinese economy, the manufacturing sector. All of which points to a bottoming of GDP this quarter, as we previously anticipated. This should bode well for the main support strut of the Australia economy, the mining sector, which has been a point of concern for the RBA.
On the other hand, domestic economic data has been fairly mixed over the last month. Whilst we saw an increase in the labour force participation rate, building approvals, home loans and consumer confidence, the RBA is also faced will abysmal levels of business confidence, struggling non-mining sectors of the economy and a big hit to non-residential housing. Also, the RBA’s commodity price index declined during October, which raises concern about a further deterioration in Australia terms of trade.
Perhaps the most important aspect to consider, at least from a domestic perspective, is inflation. Almost single handily, Australia Q3 CPI data turned sentiment regarding a November rate cut. Market pricing suggested that around 70-80% of investors we predicting a 25 bps rate cut before the release of the CPI data, compared with just 50% now. However, although inflation is technically around the middle of the RBA’s target range of 2-3% post release, which theoretically makes a rate cut less likely, the jump higher was largely attributable to a one time effect from the government’s carbon tax. Hence, we don’t expect to see inflation push significantly higher from here. This was backed-up by producer prices over the same period, which only increased 0.6%.
However, more often than not the bank will cut the official cash rate in consecutive months, as opposed to a single cut. Furthermore, Stevens seems to enjoy adjusting monetary policy in November, having cut rates then every year since hit took the top job in 2006. Although these aren’t fundamental reasons to cut, they do provide some insight into the psychology of the RBA board.
Overall, a case could be made for a rate cut if the RBA anticipates threats to domestic growth stemming from offshore will intensify, especially when combined Australia’s weak terms of trade and high domestic currency. Whilst we think the RBA’s concerns about China have somewhat eased in the month, there is still the ever present threat of the European debt crisis and the fiscal cliff in the US. On balance, we are inclined to think the RBA will return to its wait-and-see mode, but it is going to be a very close call.
This week’s rate decision may lead to some very interesting and jumpy price action due to disagreement between market participations about what the RBA will do. Australia’s Q3 inflation data and the corresponding price action in the swap and interbank futures markets created room downside action in AUD if the RBA cuts the official cash rate. However, if the RBA doesn’t cut the official cash rate then we expect to see AUD leap higher. In particular, AUDJPY will be an interesting pair to watch if the RBA leaves rates unchanged, due to the dovishness coming from the BoJ.