FX comment – RBA maintains monetary policy and economic outlook

by: Roy Teo

  • RBA leaves monetary policy and economic outlook unchanged
  • RBA monetary policy dilemma
  • Australian dollar supported as the RBA did not increase its dovish tone


RBA leaves monetary policy and economic outlook unchanged

As expected the Reserve Bank of Australia (RBA) left monetary policy unchanged today. Economic growth is projected to be a little below trend over the year ahead. The RBA reiterated that the strong increase in resource exports seen in the first quarter of this year is unlikely to persist in the coming quarters. Indeed the trade balance has turned from surplus in the first three months of 2014 to a deficit in the second quarter as exports declined. The central bank also maintained their view that investment in the resource sector is starting to decline significantly with improvement in investment intentions in other sectors remaining tentative. On the labour market, the central bank forecasts that it will be probably some time before unemployment declines consistently. With regards to the strong inflation print seen earlier this year, the central bank did not seem concerned as it stated that it was due to the decline in the Australian dollar last year. Looking ahead with wage growth expected to remain modest over the period ahead, inflation is expected to remain within the 2-3% target even with a weaker currency. In conclusion the central bank stated that the most prudent course for monetary policy is likely to be a period of stability in interest rates.

RBA monetary policy dilemma

We empathise with the RBA’s dilemma for the following reasons. On one hand dwelling prices continued to rise in June and July with investors’ share of housing credit at the highest level in the past decade. This poses the risk that the central bank may need to tighten monetary policy earlier to curb the rise in property prices and investors’ speculation. The outlook for the service sector is also looking more promising. We expect the service sector to gradually recover in the coming months as consumer confidence has rebounded back to pre Budget levels. Signs of deterioration in the labor market have also eased as both the employment sub indices in the manufacturing and service sectors rose in June and July. This is also reinforced by the rise in job advertisements in June and July which imply that the unemployment rate in July (due to be released on 7 August) could decline from June’s level of 6% compared to market consensus of a steady rate. On the other hand due to continued slack in both the manufacturing and service sectors, we judge that wage pressures are still a distant reality. In addition the transition from a mining led economy to a more broad based economy remains slower than desired. The manufacturing PMI’s rise from 48.9 in June to 50.7 in July was due to rise in inventories. Looking at the trend between new orders and inventories, we do not expect the improvement in the manufacturing sector to persist in the coming months. With the strong exchange rate and lower commodity prices net exports are likely to be a drag on economic growth in the coming quarters. We maintain our view that the RBA is likely to keep monetary policy unchanged until the second half of 2015 as economic growth picks up. On the housing market, we doubt that the RBA will pull the trigger by raising interest rates this year as there are signs that the exuberance in the housing market is cooling. Growth in home loan approvals has slowed and household debt to GDP has also declined in the first quarter of this year. Looking ahead, though the RBA has stated that it does not favour further macro prudential tools to cool the housing market but instead prefer to rely on tougher banks’ lending standards and provisions, we expect the central bank to implement targeted measures to cool the housing market while leaving monetary policy unchanged to aid the rebalancing in the economy and to not push up the exchange rate.

Australian dollar supported as the RBA did not increase its dovish tone

After the RBA monetary policy announcement, the Australian dollar (AUD) rose by about 15 pips to 0.9340 as the RBA did not increase its dovish tone on the resilient exchange rate. The RBA reiterated that the exchange rate remains high by historical standards and is offering less assistance in achieving balanced growth in the economy. In the options market, the demand to hedge downside risks in the AUD has also eased in the last few days. We continue to favour fading the current relief rally towards 0.9350 with a one month downside target of 0.92. This will be mainly driven by a stronger US dollar as the outlook on the US economy improves and more Fed officials dissenting that monetary policy will remain low for a considerable time after asset purchases conclude. Indeed adding to Fed Plosser and Richard Fischer comments last week, Fed Lacker who votes on monetary policy next year said that investors are underestimating the pace at which the Fed will raise interest rates over the next two years. We maintain our view that the US dollar will gain momentum in the coming months as the US economy improves and the Fed has less flexibility to remain dovish.