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RBA Warming to the Idea of Rate Cuts

Last updated 10/4/2011 12:24 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

The uncertainty in the global economy and the volatility in the financial markets is finally catching up to the Reserve Bank of Australia. For the past few months, investors had been discounting a 50 to 100bp rate cut before the end of the year but up until today, the RBA has not been willing to even consider lower interest rates. In this month's RBA statement however, the central bank is clearly telling us that they are open to the idea of easier monetary policy which is why investors sold the Australian dollar following the RBA announcement. In the monetary policy statement, the central bank said "an improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary."  In other words, if inflation declines due to weaker economic conditions, the RBA will be ready to cut interest rates.  This represents a major shift for the central bank because they are finally acknowledging the concerns of investors who are discounting 70bp of easing by year's end.  Although the RBA still feels that the terms of trade in Australia are very high and investment in the resources sector is picking up, the deterioration in the labor market, cautious spending behaviors and the earlier rise in the exchange rate has  led the central bank to admit that "near-term growth is unlikely to be as strong" as they previously expected.  They are also beginning to share the inflation concerns of other central banks.  According to the RBA statement "recently revised data show a pick-up to date in the underlying pace of price rises that was less sharp than initially indicated." Back in September, the central bank was still worried about the medium term inflation outlook but now they are far less concerned about price pressures getting out of hand.  Growth in China, their largest trading partner continues to expand but lower GDP forecasts for the Asia region has made Australians worried that they could fall victim to a simultaneous slowdown in U.S. and China.  This of course is not out of the question as China is already beginning to the feel the consequences of weaker global demand. 

The RBA left interest rates unchanged at 4.75 percent but the main takeaway today is that they took a baby step towards easier monetary policy.   Given the recent sell-off in risk and the current trend of the global economy, there is a reasonable chance the RBA will need to step in and provide support for the local economy.  With interest rates at 4.75 percent, they have plenty of room to ease but in order for them to pull the trigger on lower rates, they will probably need to see more signs of slower growth in Asia.  It is also important to realize that even though the RBA reduced their degree of hawkishness, they are still waiting for more signs of weaker growth before pulling the trigger on lower rates.  Yet they won't be afraid to do so if Australian economic data weakens significantly or the financial markets experience a deeper slide but so far, there is very little sense of urgency.  The RBA is simply loading up their guns and preparing for battle if the winds happen to blow in the wrong direction.  For the Australian dollar, the central bank's increased willingness to lower rates will probably cap gains in the Aussie. 

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.