The Reserve Bank of Australia’s (RBA) July meeting minutes were released today.
It’s usually a non-event for financial markets, merely elaborating on what was communicated in the post-meeting policy statement.
But not today. Oh no.
In comparison to the cautious tone seen in the policy statement, something that saw financial markets price in a smaller likelihood that interest rates will move higher in the short-to-medium term, the tone of the minutes was significantly more upbeat, particularly in relation to the Australian economy and labour market conditions.
The statement and minutes were like chalk and cheese, and, as when the former was released two weeks ago, the minutes have had an immediate impact on Australian financial markets.
Only this time it’s been the exact opposite reaction.
A lengthy discussion on the “new” neutral level for official Australian interest rates, something some have deemed to be an attempt to prepare markets for tighter monetary policy settings, has only helped to reinforce the view than rates could be moving higher sooner than what many had expected.
Quite a turnaround to the discussion being had only a few hours ago, right?
Now that they’ve had time to digest the minutes, it’s time to see what Australia’s economic community has made of it all.
Is it really a game-changer on the outlook for Australian interest rates, or is this simply the markets jumping at shadows?
Let’s find out.
Ivan Colhoun, National Australia Bank
Today’s minutes reinforce the recent more positive shift in the RBA’s assessment of the outlook for the Australian economy, noting stronger employment data have reduced wages downside risks, some improvement in Western Australia and Queensland, better consumer spending in the June quarter, the temporary nature of growth weakness in Q1, a continuing improvement in the global economy and increased infrastructure spending as fiscal spending exceeds the Bank’s expectations.
That said the board continues to carefully monitor developments in both the housing and labour markets, which suggests little inclination to move rates in either direction at the current time. The board has been encouraged by recent stronger than expected labour market outcomes, and further gains are signaled by leading indicators such as SEEK job ads and the NAB Business Survey’s employment index, both of which have strengthened in recent months.
The main talking point was the discussion of the neutral interest rate in Australia, which the RBA places at 1% real and 3.5% nominal (1% real plus the 2.5% midpoint of the 2-3% inflation target). Does this suggest the Bank is getting ready to follow other central banks in beginning the track back to neutral?
While the discussion may reflect the bank beginning to think about where rates ultimately end up as growth recovers to potential and spare capacity in the labour market reduces, there is little indication that the bank is close to following its global counterparts in raising rates. It’s likely that – as in 1994 – the RBA will lag the Fed cycle because we have more spare capacity in the labour market.
The course of unemployment — and underemployment in particular — will be more important for markets in coming months.
Kristina Clifton, Commonwealth Bank
Markets were left disappointed as the statement accompanying the July decision was very neutral and downplayed both signs of strength and weakness. However today’s minutes seemed to have a more positive tone overall with the RBA acknowledging recent strength in the labour market and the generally positive flow of data for the June quarter, abstracting from the effects on coal exports from cyclone Debbie.
Nonetheless we don’t think rate rises are back on the cards yet and we would need to see an upgrade to inflation and wages forecasts to change our view of policy on hold until well into next year. The RBA would also be taking account of the fact that monetary conditions have tightened without any official rate increases. Firstly, the major lenders have all lifted rates for investors and interest only borrowers. Secondly, the Australian dollar has had a strong run in recent months, and is now up close to the 0.79 USD mark, compared to the average level of just under 0.75 USD for the past 18 months or so.
The RBA has estimated the neutral real cash rate to be around 1%. This equates to a neutral nominal rate of around 3.5%. This is below our estimate of 3%. The neutral rates is thought to have declined since around 2007 due to lower potential growth as well as the increase in risk aversion. The Minutes don’t elaborate further on this point. But we are likely to see further communication from the RBA on this topic in the coming months.
Michael Turner, RBC Capital Markets
The July meeting minutes were supposed to be a drab affair given the damp squib that was Lowe’s post-meeting statement and the proximity of the full forecast update in August. To be sure, the tweaks to existing discussions pertaining to recent data were indeed modest, albeit marginally upbeat. The labour market continues to improve, household consumption looks better in Q2 than Q1, public demand appears to be adding more to growth than expected, and data on global economic output have also been on net better than expected.
However, the board had what appears to be an in-depth discussion of some internal RBA work on the neutral level of the cash rate. The board concluded that “all estimates of the neutral real interest rate for Australia suggested that monetary policy had been clearly expansionary for the preceding five years or so”. Moreover, the board added that “a reduction in risk aversion and/or an increase in the potential growth rate could see the neutral real interest rate rise again.”
With the cash rate 200bps below neutral according to the RBA and the unemployment rate falling to 5.5% in May, the discussion on the neutral rate has prompted a sharp reaction in markets.
We still struggle to see how the cash rate will be going anywhere over the next 18 months with an underlying inflation rate entrenched below 2% and a cooling housing market, but the August set of communication will be an important chance to better check the RBA’s pulse.
Bill Evans, Westpac
The most important result from the minutes of the monetary policy meeting of the RBA board was to finally nominate the bank’s estimate of the “new neutral real interest rate for Australia”. The minutes highlight that the bank now believes that the neutral nominal cash rate is around 3.5% indicating a neutral real rate of 1% on the basis that medium term inflation expectations are around 2.5%. Consequently any move back to neutral would involve around 200 basis points (BPS) in tightening.
If the mortgage rate increased by a further 200bps, the evidence of 2011 suggests that house prices would likely fall — hardly what one might assess as a neutral policy stance. Overall, in the current circumstances, this neutral rate, looks too high.
Arguably, the discussion around the neutral rate can be interpreted as laying the foundation for a tightening cycle. However with uncertainty around wages and inflation, the consumer, the labour market and housing, it would be inappropriate to over interpret this signal.
The bank is encouraged that lead indicators continue to point to further improvements in (labour market) conditions. The unemployment rate is now only 0.5% above the generally accepted full employment rate for Australia. A sustained move towards 5% would certainly encourage the bank to consider higher rates. However, there would need to be some evidence that wage pressures were also responding since underlying inflation remains anchored below 2%.
Despite a more confident Bank and its decision to set out its new so-called “neutral target”, our forecasts remain consistent with the cash rate staying on hold throughout 2017 and 2018
Sally Auld, JP Morgan
The July RBA statement was notable for its strong neutral bias at a time when a number of G10 central banks had started to move in a more hawkish direction. However, our take is that the tone of the minutes from the July Board meeting contain a more optimistic tone, relative to that presented in the statement.
The tone of commentary on the domestic economy doesn’t suggest growth or inflation forecasts are ripe for downward revision in the August Statement on Monetary Policy.
The key issue for markets will be whether or not the discussion on the neutral rate is interpreted as some sort of signal. We don’t think this is the case. After all, the discussion is sympathetic with the RBA’s consistent description of policy settings over the past year as accommodative. And if Board members were briefed on new work by the Bank staff on this topic, then it is simply a matter of procedure that the discussion rates a mention in the minutes.
Neutral rate estimates aside, the minutes still make it clear that the RBA is watching both the labour and housing markets carefully and, that despite a better tone to data of late, accommodative policy remains the right setting. The extent to which better labour market conditions continue will be key to how long this assessment sustains.
David Plank, ANZ
In commenting on the RBA’s early July statement we concluded that if anything the Bank’s tone was a little more downbeat. This is not a sentiment we gain from the minutes to the July meeting. For instance, the assessment in early July that the March quarter slowdown was only “partly reflecting temporary factors” has been changed to one that is “largely reflecting temporary factors”.
The unexpected discussion about the neutral cash rate and the focus on the RBA’s estimate of 3.5% emphasises just how stimulatory current policy settings are. Is this the signal the RBA intended to send the market?
Certainly the market has interpreted intent from the Bank.