Insight: RBA Unlikely to Keep Powder Dry, Nov Cut Likely

By Sophia Rodrigues

The Reserve Bank of Australia doesn’t believe in the “keep the powder dry” argument with regards to monetary policy, and would therefore be prepared to lower the cash rate if its updated forecasts for the economy next month make a case for more stimulus.

There is thus a strong possibility of a 25bps cut in November to 0.5%, especially if the upcoming labor force survey for September, and the third quarter consumer price index inflation data result in downgrade in growth and inflation forecasts.

The RBA’s next cash rate decision is on November 5, and  while the Statement of the Monetary Policy is due on November 8, the forecasts contained in the statement will be available for discussion at the cash rate meeting.

It is important to note that any further rise in housing prices is unlikely to deter the RBA from effecting another cut.

The RBA’s thinking is reflected clearly in the minutes of the October board meeting, published Tuesday.

For the first time, the minutes contained a very detailed account of the debates that took place while considering monetary policy decision.

One of the discussions was around the argument “Keep your powder dry,” which essentially means it is better to delay policy action even if there is a case for lower rates now because cutting rate would lead to a decline in confidence.

In the minutes, the RBA said such an argument “requires changes in interest rates to be the key driver of demand, rather than the level of interest rates” but experience has shown the latter is the  more important determinant.”

The RBA is, thus, clearly dismissing the argument to keep monetary stimulus in reserve for any future negative shocks because it is more important to take action when it is needed so the starting point of the economy is improved to deal with any future shock.

The fact that the cash rate in Australia is currently close to the Effective Lower Bound strengthens the argument to do more now to support employment and ensure inflation expectations remain anchored to the RBA’s target band.

The minutes also revealed the RBA isn’t worried about rising housing prices because it is part of transmission mechanism of policy, and is needed to encourage housing construction. Given that dwelling investment fell more than expected in the second quarter, and the expectation is for further decline over coming quarters, the RBA would welcome any upswing in housing construction.

The RBA would only be worried if it sees evidence of faster credit growth, weak lending standards and rising leverage, and it’s unlikely any of this will happen in the next few months.

(For a better understanding of this article, I would recommend you also read my previous article “Could RBA Prevent QE”)