RBA Warrants Doing Less as China is Doing More

As a surprise to the market, the RBA announced to keep the overnight cash rate unchanged at 3.75%, following 3 consecutive raises last year, as policymakers would like to gauge the impact of previous hikes and stimulus withdrawal.

There are several reasons triggering the RBA to pause monetary tightening, in spite of strong domestic data and the 2-month break since the last meeting. Chinese authorities are now seeking to reduce the degree of stimulus to their economy and this may affect economic development in Australia. At previous meetings, the RBA stated 'growth in China has been very strong, which is having a significant impact on other economies in the region and on commodity markets'. As Australia and China are close trading partners, tightening in China may increase concerns over a temporary slowdown in Australia's growth.

The RBA realized domestic lenders 'have generally raised rates a little more than the cash rate over recent months and most loan rates have risen by close to a percentage point'. In December, the Deputy Governor Battellino said that it's 'reasonable to conclude that the overall stance of monetary policy is now back in the normal range' after lenders raised borrowing costs 'above their previous cyclical lows. This probably is one for the major reasons causing the pause.

The RBA's decision today signaled a pause, rather than the end of the tightening cycle. In fact, interest rates remain expansionary. We expected the central bank will resume hiking rates in coming months and by year end, the cash rate should reach 5% to 5.25%.

AUD tumbles after the announcement but we believe expectations for further tightening should limit the decline. Another focus is on the February SMP which will be released Friday. The RBA will probably revise up its GDP forecasts for 2010 while maintaining the inflation outlook.