RBA Cut Rates In December As Situation In Eurozone Deteriorated Sharply

The RBA minutes for the December meeting indicated that the rate cut in the month was mainly driven by the dire situation in the Eurozone (in November, the rate cut was due to weaker-than-expected inflation). Domestic economic situation has softened but it has not weakened to an extent that a reduction in interest rate was needed. Indeed, policymakers continued to believe that growth would be close to trend in coming few years. The central bank did not give any hint of monetary policy outlook. However, given the highly uncertain global economic outlook, especially in the Eurozone, and the moderation in inflation, further easing is likely to be seen in as soon as early 2012.

It's stated clearly that board members have discussed much about sovereign debt problems in the Eurozone. Deterioration in financial market sentiment in November reflected the 'difficulty European policymakers were having in dealing with the debt crisis' and 'political instability' in some Eurozone countries. The RBA noted that a number of banks were seeking to increase their capital ratios to 9% by mid 2012 by selling assets and by scaling back trade finance. These moves increased the risks of dampening economic activity and the region is expected to record little growth in 2012. Developments in Europe continued to 'pose downside risks to the global economy and, consequently, also to Australia. These risks had, if anything, increased though the timing and magnitude of any effects that might flow from them remained very difficult to predict'.

The economic condition in Australia remained positive during the period. At stated in the minutes, 'a major investment boom was in progress and the overall economy was expanding at a pace broadly in line with trend' and Australia's 'main trading partners also still recording strong growth'. These developments 'did not suggest any strong need to cut interest rates'. Concerning inflation, it is expected to be 'consistent with the target over the next couple of years'. Taking everything into consideration, the RBA believed it would be prudent to lower interest rates for a second consecutive month in December.

No hint of further rate cut was given in the minutes. However, a weak CPI report for 4Q11 to be reported on January would be a triggering factor for a reduction of -25 bps in February. Headline CPI eased to +3.5% y/y in 3Q11 from +3.6% in 2Q11 while core inflation came in lower than expected. For the fourth quarter, fuel prices would likely be flat and a drop in fruit and vegetable prices would drag down the headline CPI. The central bank might view it reasonable to lower interest rates further.