Rate cuts await
WESTPAC’S esteemed chief economist Bill Evans believes the Reserve Bank has switched focus from the slowing economy – due to the downturn in mining – to a new focus on the exchange rate.
Mr Evans believes the Reserve may still need to stimulate the economy if the Australian dollar stays stubbornly high, and the way to do this is through lower interest rates – and it will eventually reach this decision.
He said the minutes to the last RBA meeting showed clear emphasis on the exchange rate, quoting the minutes as saying ‘‘members noted that a lower level of the exchange rate would likely be needed to achieve balanced growth in the economy’’; and ‘‘the Australian dollar, while below its level earlier in the year, remained uncomfortably high’’.
With great anticipation economists attended Reserve Bank Governor Glenn Stephens’ speech to the Australian Business Economists on November 22 which was titled, The Australian Dollar –Thirty Years of Floating.
Mr Evans said: ‘‘At one stage of the evening the Governor noted that interest rates are at a 50-year low even though growth and inflation are not at 50-year lows – that being because the exchange rate is so high. The clear implication is that if financial conditions are to be eased then a lower exchange rate is a preferable option.
‘‘Presumably, unease with prospective movements in house prices is the source of discomfort in using the interest rate lever any further. In earlier speeches the Governor has indicated that, to date, house prices have not moved out of line with incomes. The trajectory of house prices over coming months will be a key determinant as to whether the Bank believes that, in fact, it still does have some interest rate flexibility.
Mr Evans went on: ‘‘It is our view that the economy will evolve to indicate that further stimulus is required and interest rates are the appropriate instrument.
‘‘At present it appears that the Bank believes that the currency is the appro- priate source of further financial easing. Given that it has not established that the Australian dollar is necessarily markedly overvalued nor do we have any clear idea of the future path of the terms of trade or the policies of the major central banks it seems to me that interest rates offer a much more reliable option for further stimulus. Relying on lowering the currency by ‘jaw boning’ or unconventional, and potentially risky, means seems less attractive especially when, by global standards, we have ample flexibility around interest rates.
‘‘ In summary, the Reserve Bank does acknowledge the economy needs further stimulus. However its preferred policy approach is through the AUD.
‘‘With uncertainty around whether it is indeed overvalued; the vagaries of policies in other central banks and the terms of trade; and the risks associated with intervention, it is my view that interest rates represent a much more certain and less risky option.
‘‘In time we expect that the Bank will come to a similar conclusion.’’