Australian, New Zealand currencies

On August 5, the Reserve Bank of Australia (RBA) shifted to an explicit easing bias. While the shift in the bank's statement focuses on the shift in the growth picture, one also wonders whether recent comments from some major Australian banks have played a role. By signalling that a near term RBA rate cut would not necessarily be passed on through lower borrowing rates, the banks have signalled a potentially significant blunting in the monetary policy transmission mechanism.

While this is unlikely to have been a significant concern for the RBA until recently, given the banks were moving conditions in the same direction as the RBA, and may still not be a concern, this could become a much more important consideration as time goes on.

Particularly against the backdrop of correcting global commodity prices, the market will now spend its time trying to pick the timing of the first interest rate cut. The front end is now pricing a near certainty of a 25 basis points rate cut by September, and another 25 basis points by December. Ultimately, the run of local data, conditions in financial markets, and the international signals will determine when the bank moves.

The RBA's statement was very similar in structure to that posted following the July board meeting. The key shifts have been the paragraph covering growth, and in the two concluding clauses. While not outright dovish on growth in the body of the text, the bank did point to the fact that conditions have restrained demand, surveys suggest a softening in business activity, and labour market conditions have eased. The two concluding paragraphs are clear:

"Given the opposing forces at work, considerable uncertainty has surrounded the outlook for demand and inflation. On balance, however, it is looking more likely that demand will remain subdued, and economic growth will be fairly slow, over the period ahead. Inflation is likely to remain relatively high in the short term, with the Consumer Price Index (CPI), affected by high global oil prices. Looking further ahead, inflation in both CPI and underlying terms is likely to decline over time, given the outlook for demand, provided wages growth remains moderate. The bank's forecast remains that inflation will fall below three per cent during 2010.

"Weighing up the available domestic and international information, the board judged that the cash rate should remain unchanged this month. Nonetheless, with demand slowing, the board's view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing."

At the very least, the RBA is signalling that the factors justifying a very tight monetary stance have disappeared. This does not suggest a shift to monetary policy becoming growth-supportive, but it does suggest that the bank believes that the case for aggressively restraining demand has slackened. This indicates that if the RBA is to move rates in the near term, it will be to ease.

Meanwhile, the New Zealand economy has started to show worrying signs of deterioration, with a number of different shocks underway. The housing market downturn is now working to weaken domestic demand, as are high oil and food prices, though the positive dairy price shock is stimulatory for farmers and associated industries.

Like most of the G10 countries, the Reserve Bank of New Zealand (RBNZ), is reluctant to cut interest rates too aggressively as inflation is still an important issue. Rises in food and oil prices are also directly feeding into inflation and pose an upside risk to inflation expectations. On the growth side, exports in June fell 4.2 per cent. Meanwhile exporters confidence also dropped.

The current weakness in the economy allows room for rates to be cut, while ensuring inflation, and inflation expectations, come down over the medium term to within the target range. Although currently inflation expectations appear to remain anchored at a level consistent with the target range, the RBNZ acknowledged that there has been a slight upward drift. In such a situation the key requirement is that policy is kept tight enough to ensure that inflation expectations remain anchored. However, analysts believe that the RBNZ can afford to lower rates in response to a weakening economy.

The NZD remains under pressure with new lows for the year being recorded recently against the USD. Recent developments suggest that the NZD may strengthen in relation to the AUD. Analysts believe this is because fears of a downturn have already taken effect in New Zealand, while these fears are likely to become prevalent in Australia in the near future.

This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.