Analysis: RBA Lowe’s Confusing Guidance Means We Missed Key Line

From pricing just 20% probability of a 25 basis point cash rate cut, Australia’s money market is now pricing over 100% chance, making it very likely the Reserve Bank will lower the cash rate when it meets on Tuesday.

The swift move in pricing was caused by an article by Herald Sun commentator Terry McCrann who on Friday evening wrote “we will now all-but certainly get a rate cut from the Reserve Bank on Tuesday.”

The certainty expressed in that line from a journalist who not long ago wrote the RBA will be on hold this year and the next, raises the question of sourcing but that’s a separate debate.

CLEAR EASING BIAS BUT GUIDANCE CONFUSING

It’s interesting that until Friday economists were near-unanimous in their view the RBA will leave the rate on hold at 0.75% on Tuesday. It’s not that that none of them recognized the growing risks to the local economy from coronavirus outbreak turning into a pandemic but because the RBA had indicated that the hurdle for further easing was very high, they didn’t change their view to an earlier cut.

The RBA’s forward guidance at the February board meeting and subsequent statements stated that the “Board would continue to monitor developments carefully, including in the labour market, and remained prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.”

By itself, the guidance suggests the RBA has a clear easing bias, and based on latest economic data and global developments, including coronavirus, would have prompted many economists to forecast a rate cut in March.

However, Governor Philip Lowe fine-tuned this guidance further by saying the RBA would be watching the labor market carefully, and the rise in household debt amid rising housing prices.

“If the unemployment rate were to be moving materially in the wrong direction and there was no further progress being made towards the inflation target, the balance of the arguments would tilt towards a further easing of monetary policy,” Lowe said at the Parliamentary testimony last month.

“A further reduction in interest rates could also encourage additional borrowing at a time when there was already a strong upswing in the housing market,” the RBA said in the minutes of February board meeting.

Market and economists were so focused on this fine-tuned guidance that none were willing to forecast a cut as soon as March despite some poor run of local economic data and evidence of dampening effect on the economy from coronavirus.

In hindsight, it appears that instead of putting emphasis on the data points suggested in the guidance, it is Lowe’s comments on the “balance” that is more important for monetary policy.

That balance is really about the short-term benefit of further lowering the cash rate versus the longer-run macrostability risk from low interest rates.

One thing Lowe was very clear about is that there is at least some benefit from lowering interest rate.

“The point which I'm trying to emphasise is I think there would be further benefits or there would be some benefits of a cut in interest rates. The cuts so far have helped households repair their balance sheets, and as their balance sheets get into better positions, people will start spending. A further cut in interest rates could add to that process.” he said at the February testimony.

THE KEY LINE WE MISSED

Lowe also stated that the balance between benefit and risk could change over time.

“We recognise though that the nature of the balance between the benefits of lower interest rates and the risks can change over time and that balance is very much dependent upon the state of the economy.”

It is this key line that many missed, including me.

Even though my own view has been that the effect of coronavirus on global and local economy could be bad or even worse than the global financial crisis, I still focused more on the risk side of Lowe’s guidance.

As it turns out, any macrostability longer-term risk is clearly outweighed by the sharp escalation in near-term risk to the economy. And that means the balance between benefit and risk from lower interest rates has clearly tilted in favour of lower cash rate.