RBA Review: Road to Recovery

Consistent with market expectation, RBA decided to keep cash rate unchanged at 3% today after a 25 bps reduction 4 weeks ago.

Since the last meeting, there have been signs of stabilization in several countries and financial markets have improved gradually. Policymakers believed that pickup in the Chinese economy, rebounds in commodity prices, together with the economic stimulus employed so far should help contain the downturn and 'provide significant support domestic demand over the period ahead'. Therefore, the central bank would like to take a pause and observe the impacts of the monetary and fiscal stimulus, which included 425 bps cut since September 2008 and AUD 90B government spending, on the economy.

The tone of the accompanying statement was rather neutral, indicating the central bank is not rush to reduce interest rate further, though one should not rule the possibility. We agree with the central bank's decision to remain on sideline for the time being as it remains uncertain how much of the massive rate cuts will be passed to the public. In fact, since April's reduction, 2 commercials raised mortgage rates, indicating many banks remained uncomfortable to pass the low interest rate to end-customers.

Moreover, despite initial appearance of 'green shoots' in world economy, contraction remains in progress. It's wise to keep some 'bullets' for future use. Employment situation in Australia continued to deteriorate with unemployment rate risen to 5.7% in March, the most in 18 years, from 5.2% a month ago. IMF forecast unemployment rate in Australia to surge to 7.8% while some analysts anticipated it to reach 10% by 2010.

RBA will also release its growth and inflation forecasts in the quarterly Statement on Monetary Policy (SMP) Friday. While a downgrade in estimates is likely, the degree should be milder than before. Last week, the Governor stated that he expected the Australian economy to fare better than its major trading partners. In today's meeting, he also said that decline in exchange rate has pushed up imported inflation although capacity utilization would decline and both domestic and international demand would remain weak for the rest of the year.

We continue to believe that RBA will have further rate cuts, probably by 25 bps, in mid-2009. However, the actual size and timing should depend on how domestic and global economies evolve and the pass-through of low interest rates by commercial banks. Of course, results and market reaction of the Fed's stress test and upcoming economic data in the coming months are crucial swing factors.