RBA minutes causes ruckus

18 July 2017

It is not often the minutes from an RBA meeting cause a stir. Most of the time, analysts and economists look for small differences in wording from one set of minutes to another. Any change is thought to imply a change in the RBA Board’s thinking, especially when everyone, including the RBA Board, is aware of the scrutiny the words in each set of minutes is given. So it is rare for anything blatant to be included.

The July minutes were different. The publication of the minutes triggered an immediate rise in bonds yields, the Aussie spiked against major currencies (from 78.0 U.S. cents to 79.1 U.S. cents) and the odds of a rate rise in 2018 increased markedly, with a second increase also partially factored in.

Not only were the minutes more positive in tone but a new paragraph was inserted and it contained an unexpected discussion of the neutral cash rate, which is the cash rate which neither promotes nor hinders economic growth. This is the paragraph in question:

“Members discussed the Bank’s work estimating the neutral real interest rate for Australia. The various estimates suggested that the rate had been broadly stable until around 2007, but had since fallen by around 150 basis points to around 1%. This equated to a neutral nominal cash rate of around 3.5%, given that medium-term inflation expectations were well anchored around 2.5%, although there is significant uncertainty around this estimate.”

The neutral rate has been receiving a lot of air time lately. Janet Yellen talked about it in her testimonies to various U.S. congressional bodies and when MPC member Kristin Forbes talked about the natural rate she was implicitly referring to the real neutral rate, which is the neutral adjusted for inflation.

The RBA’s discussion regarding the Australian neutral rate does seem a little coincidental in this context and the RBA Board would not add this paragraph without reason. That’s the view of several economists. One of them, Deutsche Bank chief economist Adam Boynton, thinks the RBA was providing a hint to various parts of the Australian economy. He said, “We have always been a little cautious about the use of ‘neutral’ rates. Nonetheless, the inclusion of the paragraph above by the RBA would suggest a degree of signalling by the Bank to other actors in the economy (likely households) about where interest rates in Australia could actually end up.”

ANZ’s David Plank took a similar line. “What’s more, the unexpected discussion about the neutral cash rate and the focus on the RBA’s estimate of 3.5% emphasises just how stimulatory current policy settings are. Is this the signal the RBA intended to send the market?”

Whatever the message, it has focussed a lot of minds on the path the RBA is thinking about for an eventual return of less-stimulatory monetary policy. It is, after all, eight years since the GFC and one could be forgiven for expecting record low official rates to be a thing of the past.

(As at 18/07/2017)