As had been the case a month earlier, the papers sent out to members of the Reserve Bank Board the Friday before their most recent meeting on Melbourne Cup Day, contained a recommendation that the cash rate be lowered by 50 basis points.
However, whereas Reserve Bank of Australia Governor, Glenn Stevens, proposed to the October meeting that, in view of the deterioration in the economic outlook during the days between the distribution of the Board papers and the meeting itself, and of the uncertainty surrounding the extent to which the banks would pass on any reduction in the cash rate, it cut the cash rate by 100 basis points, at this month’s meeting he proposed that Board members “consider the choice between a reduction of 50 basis points and one of 75 basis points”, according to the minutes of that meeting published yesterday.
As was announced after the meeting, the Board decided for the bolder option, and decided to cut the cash rate by 75 basis points. Moreover, as was widely noted at that time, it refrained from repeating the caveat which accompanied the previous month’s 100 basis point cut in the cash rate that this action should “not be seen as setting a precedent” for future meetings.
The minutes suggest that five considerations were important in leading the Board towards endorsing the bolder of the two options suggested by the Governor.
First, although Board members were presented with staff forecasts that had been further revised downwards since the previous meeting to show “output growth well below trend”, they nonetheless interpreted “the most recent information” as suggesting that “the risks to the outlook remained to the downside”. This “most recent information” presumably includes 1.8 per cent decline in retail sales in September, the 1.8 per cent fall in house prices in the September quarter and (I would like to think), the 5.9 per cent fall in the ANZ job advertisements series in October; all of which were reported on the day before the Board meeting, as well as the slump in the US purchasing managers’ index for October to its lowest level since August 1982 - which was reported in the early hours of Tuesday morning (our time).
Second, although they noted that “the depreciation of the exchange rate … meant that the decline of inflation to the target could take longer than previously thought” (a debatable assertion, in my own view), Board members nonetheless regarded the risk which this posed to inflationary expectations as “manageable … in the current environment”. Taken together with the judgement about the risks to the outlook for economic activity, this represents an important statement of the Board’s assessment of the “balance of risks”.
Third, the Board appears to have been seeking a “meaningful reduction in rates paid by borrowers”, having earlier noted that previous reductions in official interest rates had been “fully passed on to housing loan rates, but significantly less so to business lending rates, in particular small business rates”. Interestingly, this latter observation came immediately after noting that “the latest bank earnings results … had been solid in the current circumstances”. Presumably, therefore, the Board was seeking to ensure that the interest rates charged to business borrowers would actually come down following their decision.
Fourth, the Board noted that markets had fully priced in a 50 basis point cut in the cash rate, and had assigned a “significant probability” to a 75 basis point move. The Board may well not have wanted to disappoint these expectations.
Finally, and arguably of greatest importance in assessing the likely outcome of future Board meetings, the minutes record that Board members saw “an advantage in moving the setting of monetary policy quickly to a neutral position”.
Historically, “neutral” monetary policy settings have been associated with a cash rate in the range of 5-6 per cent per annum, or even with the mid-point of that range, ie 5½ per cent. That was, of course, in circumstances where the standard variable mortgage rate was 180 basis points above the cash rate. Now, the spread between the cash rate and the mortgage rate has widened to around 250 basis points (and the spread between the cash rate and business loan rates by even more). Since the stance of monetary policy depends, in practice, on the rates which borrowers actually pay, this means that if “neutral” monetary policy could previously be characterized by a cash rate of around 5½ per cent, it must now and for the duration of the current crisis be characterized by a cash rate of no more than 4¾ per cent - and arguably lower than that.
Indeed, present circumstances - in which, to quote the minutes themselves, the risks to the outlook for economic activity “remain to the downside” while the risks to the outlook for inflation are deemed “manageable” - would seem to call for monetary policy settings on the easy side of “neutral”, rather than merely at “neutral”, however defined.
Hence, the minutes of the November RBA Board meeting appear to be pointing towards a further outsized reduction in the official cash rate at next month’s meeting, and (depending on the size of the cut then) again in the early months of 2009.