The Reserve Bank of Australia cut the official cash rate to 2.25% from 2.5% as we expected, but the market wasn’t as sure the bank would move rates this month. The announcement gave AUD bears all the incentive they needed to resume mauling the currency. The ensuing sell-off in the Australian dollar has sent AUDUSD through 0.7800 and 0.7700 and onto its lowest level in over 5.5 years, before finally finding some support around 0.7650.
As we explained at the end of last year, the real moment of clarity for us came with the release of Australia’s Q3 GDP numbers. For those that don’t remember, GDP expanded by a measly 0.3% in Q3 2014, completely missing an expected 0.7% growth rate. The even more disturbing news was that Australia is now in a technical income recession, with real gross domestic income falling 0.4% over the quarter, after falling 0.3% in the prior quarter. These numbers came as a big shock to the market and turned a lot of hawks into doves.
At this stage the bank appeared to be banking on a lower exchange rate reliving some pressure on the economy. Yet, the RBA continues to believe the Australian dollar is overvalued and should lower alongside continuing weakness in commodity prices, despite being around 4.7% lower against the US dollar since the beginning of the year prior to today’s meeting. The exact words of Stevens were: “a lower exchange rate is likely to be needed to achieve balanced growth in the economy”.
While the bank elected to cut the official cash rate and jawboned the aussie some more, the whole statement by Stevens’ wasn’t overly dovish and, disappointingly, doesn’t provide the market with much guidance on what the board is planning to do at upcoming meetings. The governor noted that headline consumer price growth was at its lowest level for several years, while also stating that measures of underlying inflation also declined a little (core CPI was actually slightly higher than expected in Q4) . At the same time Stevens’ pointed out that the unemployment rate was expected to peak a little higher than previously expected.
Overall, today’s meeting represents a major shift in monetary policy in Australia. The bank had remained on hold for 18 months (15 policy meetings) prior to today as it waited to assess the impact of prior easing on the economy. Now the bank has clearly lowered its inflation forecasts to better reflect changes in commodity prices and softness in the economy (we will get clarification of this on Friday from the RBA’s quarterly MPS). This opens the door for further policy loosening in coming months, but we aren’t expecting the cash rate to go below 2.00%. It’s worth noting that the housing market remains an area of concern for policy makers.