Fears that the rise in interest rates had gone too far, thanks to the extra half a per cent or more from the banks, drove the change in interest rate policy by the Reserve Bank at its board meeting on August 5.

The Reserve Bank’s move to a rate cutting stance from early this month, despite our continuing high inflation rate, can be clearly seen from the minutes of the August 5 board meeting, released yesterday morning.

To pt it simply, the bank now believes a rate cut is needed to lessen the tightness of monetary policy: or put it another way, to release the pressures of the 1.55% in rate rises from it and the banks since last August.

The key phrase from the minutes was:” Given there had been a significant change in borrowing behaviour, confidence was weaker, asset prices had declined and slower overall growth was in prospect, tighter financial conditions were not warranted. Indeed, less restrictive conditions could soon be called for, otherwise the risk of a deeper and more persistent slowing in the economy would increase.”

“Soon be called for” means next month, on September 2 and either 0.25% or 0.50%.

Looking at the above graph, the bank is taking aim at the extra rate rises loaded on by the banks and will do so via a cut of at least 0.50% in one or two instalments.

The change in the bank’s attitude to rate cuts was first noted in the statement after the August 5 meeting by Governor, Glenn Stevens, and then in two speeches last week by Assistant Governor, Phil Lowe and Deputy Governor, Ric Battellino.

While our present high inflation rate got the usual mention in the minutes, as did the rising injection of money from higher iron ore, oil and coal prices, the slowing domestic economy and the much sharper tightening in financial conditions seems to have won the day.

In fact it seems to have been fears that monetary policy had been further tightened by the extra rate increases levied by the banks from the credit crunch impact (and the unspoken impact of sharply higher petrol prices) that seems to have forced the RBA’s hand.

The extra 0.55% imposed by the banks on top of the 1% in rate rises from the RBA since last August, played a big part in producing the switch to a rate cutting stance.

There was little mention of the impact of the surge in oil and petrol prices, but they obviously had a big impact, as we have seen from some retailers’ sales figures, magazine circulation figures, especially for the June half year and several other indicators on consumer spending and consumer confidence.

The comments by the bank (in bold)  would also explain why the bank has been so forthright in bashing the banks over passing on rate cuts to consumers. 

The RBA has become fearful that monetary policy may be excessively tight!

After pointing out that the current high inflation rate, plus even higher readings later in the year “argued for maintaining the current stance of policy,” the board went on to canvass what was actually happening in the economy.

And, compared to what it said after the previous board meeting (On balance, “while members remained concerned about the current rate of inflation and the uncertainties about the outlook, the increasing signs that demand was slowing suggested that the existing policy setting was exerting the appropriate degree of restraint. Provided demand continued to evolve as expected, inflation was likely to decline over time”) the change was enormous.

“Members were conscious that financial conditions were clearly quite tight, and effectively getting tighter as a result of ongoing pressure on lenders’ cost of funds in the market.

“Given there had been a significant change in borrowing behaviour, confidence was weaker, asset prices had declined and slower overall growth was in prospect, tighter financial conditions were not warranted. Indeed, less restrictive conditions could soon be called for, otherwise the risk of a deeper and more persistent slowing in the economy would increase. (That’s the key phrase in the minutes).

“On these considerations, a case could be made for an early reduction in the cash rate.

“Weighing up all these considerations, members judged that the current stance of policy was appropriate for the time being.

“Nonetheless, given the slower trend in demand, scope to move towards a less restrictive setting of monetary policy was judged to be increasing.”

And early next month the bank will cut rates by at least 0.25% and then back up in October, or hack its cash rate back to 6.75% to ease the squeeze.

The change in policy and attitude at the RBA can be seen from comparing the above quotes with what was said after the August 5 meeting in the Governor’s statement, which again didn’t quite reflect the change in policy

 

In the statement after the August 5 meeting Governor Glenn Stevens said:

“Given the opposing forces at work, considerable uncertainty has surrounded the outlook for demand and inflation.

“On balance, however, it is looking more likely that demand will remain subdued, and economic growth will be fairly slow, over the period ahead. Inflation is likely to remain relatively high in the short term, with the CPI affected by high global oil prices.

“Looking further ahead, inflation in both CPI and underlying terms is likely to decline over time, given the outlook for demand, provided wages growth remains moderate. The Bank’s forecast remains that inflation will fall below 3 per cent during 2010.

“Weighing up the available domestic and international information, the Board judged that the cash rate should remain unchanged this month. Nonetheless, with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing. ”

But that was far different to what the bank said in its minutes of the July meeting.

“On balance, while members remained concerned about the current rate of inflation and the uncertainties about the outlook, the increasing signs that demand was slowing suggested that the existing policy setting was exerting the appropriate degree of restraint.

“Provided demand continued to evolve as expected, inflation was likely to decline over time.

“Weighing up the various factors, the Board judged that the current stance of monetary policy remained appropriate and would continue to evaluate prospects for economic activity and inflation in the light of new information.”

The change in attitude at the highest level of the RBA in the space of a month was enormous. It all came down to a bit more information

THREE of Australia’s big four banks now expect a cut in official interest rates in September followed by more rate relief by Christmas, although hopes that borrowers will benefit are slim.

Economists at major financial groups now expect the first rates cuts this year rather than in 2009 after the Reserve Bank of Australia (RBA) indicated on Tuesday it was looking at a less restrictive monetary policy stance.

Interest rates were left on hold at a 12-year high 7.25 per cent this month for the fifth successive month but RBA governor Glenn Stevens said that demand was likely to be subdued as economic growth slowed.

ANZ, National Australia Bank and Westpac now forecast a rate cut in September followed by another easing in the December quarter and more relief in 2009.

Conversely, Australia’s biggest home lender, Commonwealth Bank, says interest rates will stay on hold to the end of 2009 as the resources boom fuels inflationary pressures.

However, hopes that borrowers will benefit to the full extent from the fall in rates appear slim. The heads of Westpac and ANZ told a federal parliamentary inquiry in Melbourne into banking competition today that they would not fully pass on an RBA rate cut.

The bullish take on rates contrasts with the stance less than three weeks ago when ANZ was predicting the RBA would raise rates in August and November but the bank, Australia’s fourth biggest lender, now says rates will be cut in September and November.

“It’s amazing what a fair bit of softer data can do,” said ANZ economist Alex Joiner.

“The Reserve Bank has talked down interest rates quite a bit. They made it clear in their statement that’s what they’re going to do and that’s been convincing for us.

“They want to see softer domestic demand but they want to see wages growth remain under control.”

National Australia Bank head of economics Jeff Oughton said the RBA would cut rates in September by either 25 or 50-basis points.

He said rates would be eased by half a percentage point by the end of 2008, and predicted another 75-basis point cut in the first half of calendar 2009 that would take the cash rate down to six per cent for the first time since November 2006.

“There are tighter financial conditions and then there’s a second-round effect of falls in equity prices and a weaker housing outlook, as well as higher oil prices,” Mr Oughton said.

“Growth is going to slow and stay down well below potential for the next couple of years, so we don’t have any inflation problems.”

Westpac forecasts the RBA will ease rates by 50-basis points next month, following up with a 25-basis point cut by Christmas and yet another quarter of a percentage point easing in the March quarter of 2009.

A 100-basis point easing in interest rates by Easter would take the cash rate back to 6.25 per cent - the same level as early August 2007 before another round of tightening, with four increases - in August, November, February and March.

“It’s a case of trying to avoid these downside risks to growth which appear to be there at the moment,” Westpac senior economist Andrew Hanlan said.

“High petrol prices, the credit crunch and the Reserve Bank tightening has had a big dampening effect.”

An economist with the Commonwealth Bank’s trading arm CommSec, Savanth Sebastian, said the RBA would leave interest rates on hold as rising terms of trade, the ratio of export to import prices, helped keep inflation above the central bank’s 2 to 3 per cent target.

“We haven’t seen that rise in national income since the Korean War of the 1950s,” he said.

“With the jobs market remaining quite resilient, there’s still risk to interest rates remaining at the level they’re at.”

Mr Sebastian acknowledged rates could be cut by Christmas if spending levels did not pick up.