RBA minutes signal they don’t want to ease – but they will

September 21, 2011

FOREX, RBA and Interest Rates

Interpreting the RBA is an art form that commentators and pundits work hard at but sometimes get right and sometimes get wrong. Our analysis framework has been enhanced, we think by our recent addition of wordle maps. Yesterday’s release of the minutes from this month’s Board meeting was no different.

As we noted at the time of the Governors statement earlier this month they remain concerned about growth but this time in a negative sense. That’s fair enough given their previous concerns about inflation were driven by their strong view that growth in the global economy would be strong enough to see the mining boom wash through the economy. It is thus right to recalibrate when things change.

One thing they didn’t show any signs of re-calibrating though in the minutes was the dichotomy between what they are saying about rates, on hold, and what the market is saying – that is massive rates cuts. Indeed the minutes said,

“Members were informed that, in Australia, market pricing prima facie pointed to expectations of large cuts in the cash rate by the end of the year, but a range of technical factors meant that market pricing might not be giving an accurate reading of expectations in the current circumstances.”

Is that a nice polite way of saying the market is wrong and doesn’t believe its own pricing?

I think that’s exactly what the RBA is saying. But what traders would want to hold positions well through the current cash rate if they don’t believe in them? If that was the case then structurally rates could have had a massive rally but they would have then sold off, increased rates, in pretty quick order as the market readjusted to its true expectation after the short covering rally.

So I guess I am questioning this point the RBA staffers have made to “members” of the Board. Certainly I grant them that the fact that physical bank bill curve is only slowly dragging itself down through the current cash rate which suggests some reticence to hold assets at a negative carry. But equally I say that the approaching financial year end by 3 of the 4 majors might be a structural impediment to such a rally. Indeed even against this backdrop 3 month bills are down 16 bps in the past 4 days.

The minutes tell us the RBA still doesn’t want to ease – but it will have to eventually. i’ll post on this based on another cracking chart from Westpac tomorrow.

The good news from the minutes however was that the RBA was very upbeat about the Australian banking sector saying,

Members were briefed on the Bank’s half-yearly assessment of the financial system.

Compared with the pre-crisis period, banking systems in the major countries had strengthened their capital and funding positions over recent years. Most of them also continued to report profits in the most recent period, though overall returns on equity remained below pre-crisis averages. It remained the case, however, that many banks were still dealing with elevated levels of non-performing loans, particularly property-related loans, and their loan-loss provisioning was no longer declining rapidly from the peaks seen during the crisis. Banks in Europe were also carrying large exposures to sovereign debt whose creditworthiness had declined. Ongoing weak credit growth was weighing on banks’ underlying revenue growth and had dampened property markets in the major economies.

The Australian banking system remained in a relatively strong condition. The recent global market turbulence contributed to falls in Australian banks’ share prices and some tightening in wholesale funding conditions, but the overall effect had been modest compared with the experience in most other countries and in 2008. The Australian banking system was better placed to cope with periods of market strain than it was before the crisis, having substantially strengthened its liquidity, funding and capital positions in recent years. Profitability for the major banks had continued to improve to near pre-crisis levels, mainly because of declines in provisioning for bad and doubtful debts. While non-performing assets had yet to show significant signs of improvement, the ratio of non-performing assets to total assets remained well below the early 1990s peak.

So they are explicitly saying that Australian banks are in good shape and they said earlier in the minutes that,

The heightened volatility in markets resulted in very low bond issuance globally and in the domestic market. In any event, the Australian banks did not need to issue, given strong deposit inflows both on and offshore, and slow balance sheet growth.

This is an important point they have made elsewhere, at other times and in other speeches, about the fact that Australian Banks have not needed to fund from offshore recently. It is an important point in a fractured global market where yesterday the news was that Chinese banks are pulling European bank trading lines. It is also important in the current climate that we avoid a rerun of what occurred 2008 with heightened concerns about the level of offshore funding in the Australian banking system, concerns that persist today in some form still.

Overall a set of minutes that didn’t tell us anything fresh really but which gave us an insight into RBA thinking on interest rates and financial stability. But I’d add that the focus on growth suggests to me that the RBA may be mounting a rear guard action as to why they don’t want to or haven’t eased yet but ultimately the Australian growth profile will see this happen.

I am out of the office today and this post was loaded last night so apologies if I haven’t covered anything topical that happened while we were sleeping.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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