The Reserve Bank of Australia’s (RBA’s) decision to leave official interest rates on hold in July was no surprise to the market. That said, there were some very subtle, but important aspects to the RBA’s post-meeting policy statement that investors should be aware of.
Keep watching the unemployment rate
For starters, the RBA has re-emphasised the importance it places on trends in the unemployment rate when trying to understand the economy’s performance. In its July Statement, the RBA did away with its previous detailed analysis of disparate trends in consumer spending, business investment and public demand. Instead, it merely noted that the unemployment rate “though elevated, has been little changed recently.”
When there are clear divergent forces in the economy – as is the case today, with moderate consumer spending, strong housing construction but weak business investment and public demand – the RBA tends to fall back on trends in the unemployment rate, as the single best timely gauge of how the economy overall is traveling. In this regard, the fact the unemployment rate has remained broadly steady in recent months – despite persistent below-trend economic growth – appears to have provided some comfort to the RBA, enabling it retain only a weak policy easing bias.
Of course, that could just mean the RBA is leaving itself leeway. To my mind, it’s still possible the RBA could cut as early as next month if the Greek crisis worsens and/or the next CPI result is exceptionally low. My base case at this stage, however, is that the RBA is likely to remain on hold for at least a few more months – which may make it a stretch for the Bank to cut twice more by year-end as my current forecasts imply.
That said, on the basis that even the RBA expects below-trend growth “for some time yet”, it’s hard to believe the unemployment rate won’t rise further. The Federal Government’s May Budget, for example, still forecast the unemployment rate will reach 6.5% by June 2016.
Even at US75c, the $A is still too high
Of course, the RBA is also hoping it does not need to cut interest rate further – lest it overly heat an already hot Sydney property market. In this regard, the RBA is hoping the $A will do more of the work required to stimulate the economy, by falling a lot further. Indeed, even though the $A had by Wednesday morning weakened to a 6-year low of US 75c, the RBA still saw fit to suggest in its Statement that “further depreciation seems both likely and necessary”. My long-held view has been that the $A will fall to US68c by year end – the most bearish forecast among 25 economists recently polled by the Sydney Morning Herald – remains firmly in place.
Investors wishing to express a view that the US$ will continue to rise against the A$ can do so using our U.S. Dollar ETF (ASX: USD), which aims to track the change in price of the United States dollar relative to the Australian dollar, before fees and expenses. For example, if the US$ goes up 10% against the A$ (i.e. the A$ falls in value) the ETF is designed to go up 10% too (before fees & expenses). More information on this ETF is available here.