RBA has room to move but has time up its sleeve

Australia’s fiscal position is a point we have been contemplating into the monetary policy mix over the past few weeks. We first raised the issue in September, ahead of October’s 25-basis-point cut, where we cautioned that lower government spending in a very short period of time to produce a fiscal budget surplus would give the RBA room to move in the immediate term. See the report on the actual fiscal outcome.

Extending this thesis that the RBA has room to keep cutting is valid, but we’re not as aggressive in our timing assumptions as is the market in terms of timing. The futures market is pricing a greater than 80% chance that the RBA will cut again in November. We maintain our view that a February cut is more likely than November despite Australian Treasurer Wayne Swan today outlining the exact budget savings he will put through in order to meet his surplus targets. Lower revenue is being offset by tweaks in spending to make sure the budget remains in a circa A$1bn surplus position.

The basis behind our February timing assumptions is:

1) The RBA will want to wait and see how its recent cuts are feeding into the market. Christmas is a very important trading period for many retailers, most generate around 60% of their annual earnings in this period and consumer sentiment has slowly been improving over the past few months from a very low base. A move in November might be slightly pre-emptive, as opposed to allowing the October cuts to work through the market and then move in February should data continue on the weak side.

2) The property market is showing strong signs of confidence and the RBA has long held a view that it doesn’t see another property bubble. But recent cuts and an on-going improvement in auction clearance rates – with Sydney remaining above 60% for example – will be in the RBA’s mind before moving too aggressively before Christmas. Regional property prices in places like Shanghai, Singapore and Hong Kong have come off slightly but from a very high base and record low rates in these economies are likely to further fuel inflation.

3) By moving in October and not November, as was widely expected, the RBA is trying to maintain some element of surprise in its decision making.  It won’t want the market to take a cut for granted.

4) Unemployment is rising but the recent rate jump is unlikely to cause unease at the RBA as the number of new jobs actually exceeded market expectations. The unemployment rate had previously been a beneficiary of movements in the participation rate and September’s data saw a reversal of this trend, driving unemployment higher. We don’t think the RBA is sweating off these numbers.

These four points are general and alone do not diminish the scope for more easing, but they do add to the argument that perhaps November is not an 80% chance implied but more so a 50% chance. A December cut is unlikely and the RBA is on holiday in January. So if the above timing pans out and the RBA postpones to November, the Australian dollar will find some very solid support near current levels – all other things being equal. Perhaps this explains why despite the commitment to deep spending cuts and a fiscal surplus, the A$ remains slightly above the US$1.03 level in early afternoon Asian trading hours.