Rates will remain on hold for the remainder of the year: Westpac's Bill Evans

GUEST OBSERVER

As expected the Board of the Reserve Bank decided to leave the cash rate unchanged at 2 percent.

It also retained the key final sentence in the Governor’s statement: “Continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand.”

As we indicated in the preview by far the most important section of the statement was going to be the commentary around the Australian dollar. Since the March meeting the AUD has risen from 71.50c US to 75.75 (at the time of the meeting) having exceeded 76.50 just before the meeting. Astute observers of the Reserve Bank know that the key currency measure is the Australian trade weighted index which also had risen from 61.30 to 64.20 between meetings (an increase of 4.7%). The question was whether the Governor would attempt to ‘talk down’ the AUD along the lines he used through 2014 and up until July 2015. In fact in July 2015 when the AUD was 74.5c US and the TWI 62.5 he noted “further depreciation seems both likely and necessary”.The broad commodity price index was around the same level in July last year as it is today.

In our preview we commented that it was unlikely that the Governor would attempt to talk down the currency. In the event that proved to be correct. He certainly recognised that the AUD had risen (“somewhat”) and partly attributed it to monetary policy overseas. He also noted that an appreciating exchange rate could complicate the economic adjustment. All of these remarks are factual rather than indicating a clear intention to bring down the AUD. We can only conclude that a further substantial appreciation in the AUD would be necessary to trigger a policy response. It is interesting that the AUD lifted above 76c US in the aftermath of the statement indicating that currency markets at least were expecting stronger negative sentiment towards the recent rise in the AUD.

There has been recent talk about the importance of the upcoming inflation report due out on April 27. Westpac expects that the underlying inflation will print at 0.6%qtr consistent with the Bank’s current forecast that underlying inflation print 2.5% for the year. Surprises on inflation are always important indicators for policy and it is significant that the Governor referred to “new information … to assess the outlook for inflation”. With global financial markets settling down since the March statement the inflation report has replaced “recent financial turbulence” as the important new source of information along with labour market conditions.

A possible compromise for the Bank to put indirect downward pressure on the AUD would have been a more downbeat view on China than we saw in March. In the event the statement’s line on China was the same as March: “China’s growth rate has continued to moderate”.

Since the March meeting the Board has had the benefit of the December quarter GDP report which showed that the Australian economy grew by 3% in 2015 compared to the Bank’s forecast in February 2016 of 2.5%. Such results encouraged the Governor to continue to be reasonably upbeat about the economy: “available information suggested the economy is continuing to rebalance”; “the Board judged that there were reasonable prospects for continued growth in the economy”.

There was no change in the commentary on the housing market while the stronger growth confirmed, from the Bank’s perspective, the improved labour market conditions.

Conclusion

We are retaining our call that rates will remain on hold for the remainder of the year. That is predicated on the Australian dollar remaining broadly in the 70-76c US range. Factors that will assist the containment of the recent lift in the AUD will be a tightening by the US Federal Reserve in June and ongoing concerns about stability in China. Today’s statement certainly does not identify a trigger level for the AUD to elicit a policy response. We do not envisage a further significant surge in the AUD and remain comfortable with a steady policy outlook.

BILL EVANS is chief economist of Westpac.