Australia's RBA Sounds Optimistic Note, Holds Rates

Australia's central bank kept its key cash rate steady on Tuesday, saying the economy was faring better than feared, but left the door open to further easing if a hoped-for recovery failed to materialize.

In a statement after its monthly policy meeting, the Reserve Bank of Australia (RBA) sounded more optimistic about the global economy, particularly China, and noted the domestic economy had not been as weak as expected just a few months ago.

Yet Governor Glenn Stevens kept a clear easing bias, perhaps to deter the market from prematurely pricing in a tightening.

"The Board's current view is that the outlook for inflation allows some scope for further easing of monetary policy, if needed," said Stevens.

While the official cash rate is at a record low of 3 percent, that is still among the very highest in the developed world and way above the G7 average of 0.4 percent.

Investors seemed to doubt another cut would prove necessary and nudged the Australian dollar higher and bill futures lower. The central bank had slashed rates by 425 basis points between September and April to cushion the economy.

"The sense we get is that they're (RBA) becoming slightly more positive on recovery both in Australia and globally, and our view is that they won't act on that easing bias," said Paul
Brennan, head of market economics at Citi.

"We think rates are on hold until towards the end of the year, then we'll see the process of gradually increasing."
     
All About Unemployment

The RBA again emphasized that the full effect of past stimulus, both monetary and fiscal, has yet to be felt and should fuel a gradual recovery later in the year.

The impact of historically low mortgage rates and government tax breaks is already evident in household consumption, with retail sales strong in May and vehicle sales jumping to their third highest ever in June.

Mortgage demand has also picked up, as have property auction clearance rates, while industry data suggest home prices have begun to edge up again after a bout of weakness late last year.

Yet the recovery is all too patchy, with business investment in a slump and manufacturing in the doldrums. A survey of the construction sector out on Tuesday showed a dearth of credit was taking a heavy toll on apartment and engineering projects.

Commercial banks have also been grousing about high funding costs due to the global credit squeeze and one has gone so far as to nudge up its variable mortgage rates as a result. The RBA could thus be tempted to ease official rates to prevent any further rise in mortgage costs.

Analysts also fret that the baleful effect of sharply lower prices for key resource exports would increasingly eat into profits, tax receipts and employment as the year wore on.

And it is employment, or rather the lack of it, that could ultimately decide the course of interest rates.

Official figures on the labor market are due on Thursday and analysts expect they will show the jobless rate rose to a six-year high of 5.9 percent in June.

The government itself has predicted unemployment could reach 8.5 percent late next year, a level not seen since 1997.

"If widespread forecasts of 8-8.5 percent unemployment next year prove correct, the RBA along the way will feel the need to deliver further rate cuts," predicted Rory Robertson, interest rate strategist at Macquarie.

"Alternatively, if unemployment stabilizes much lower, maybe nearer 7 to 7.5 percent, as some now are guessing, 3 percent could well end up being the low in the cash rate."

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