How can we interpret the Reserve Bank’s (RBA) decisions about interest rates? One important tool is to understand the statement that it issues with each decision. This article provides a guide to reading and interpreting these statements (the statements can be accessed on http://www.rba.gov.au/monetary-policy/ go to ‘Interest Rate Decisions’).
The structure of the RBA’s interest rate decision announcements
On the first Tuesday of each month, except January, the RBA Board meets to decide the level of the official cash rate. At 2:30 pm (Sydney time) a statement is released in the name of the Governor announcing the decision and outlining the reasons for it.
Since early 2009 these statements have had a consistent structure to them. They almost always include the following items in the same order:
- An opening sentence announces the decision that was made that day
- Then follows an outline of the global backdrop to the decision. This always has three components
- A summary of the Board’s view of global economic growth prospects
- A statement about the trend in commodity prices
- An overview of global financial conditions, including the stance of monetary policy in the major nations.
- Then follows a discussion of the domestic scene:
- Domestic economic growth;
- A comment on labour market developments;
- A comment on inflation.
- Next is a statement about whether domestic monetary policy is easy, neutral or tight, followed by an outline of developments in credit growth and financial markets, usually explicitly mentioning the exchange rate
- The penultimate comment is about the expected impact of monetary conditions on the economy
- The final paragraph is a summary of the Board’s judgment about the stance of policy, focussing on how their objective of keeping inflation within the target range is being served. Sometimes a comment is added to provide some degree of guidance regarding the Board’s expectation for interest rate decisions in the near future.
There are occasional exceptions to this structure such as late 2010 when European sovereign risk dominated market sentiment. A comment about serious developments is included when necessary, taking over from one or more of the regular topics.
What emerges is a clear insight into the RBA’s decision-making process. It shows us the range of factors that the RBA believes are the most significant drivers of the outlook for inflation, which is the yardstick by which it judges the appropriateness of the current level for the cash rate.
Not all media commentaries after the RBA Board meeting show an awareness that the RBA has a process. You’d think that the RBA picks an ‘issue of the month’ and bases the decision around that. Whether it’s house prices or a change in the labour market or a single CPI reading, you could easily get the impression that the RBA is merely reacting to particular data releases.
Nothing is further from the truth. Were the RBA forced to front something like an asset consultant for a review, they would receive top marks for the quality and clarity of their process.
Interpreting wording changes
With that framework in mind, tracking the evolution of the RBA’s thinking needs a comparison of what is said from month to month about each of the topics, reading those changes in context.
There are three reasons for changes to the wording of the monthly statement:
- Nothing of substance has changed, but the RBA has an innocent reason for deciding to use different words this month compared to last time
- Time has moved on and the tense of the comment needs to remain contemporary
- Something of substance has changed and the RBA is telling us of their change in view.
The skilled RBA watcher can tell the difference and focus their analysis on changes that fall under category 3.
Category 1 wording changes mostly arise because there is little that changes from month to month and the RBA writers don’t want readers to get bored with exactly the same words. The RBA keeps those sort of changes to a minimum and we often see the same sentences appearing for months on end. However, sometimes when the same thing has been repeated a few times the statement will change in some way, eg. repeated ideas will be given in a more abbreviated form.
Category 2 comments are generally easy to pick for what they are – not a change of view, but an update to keep the remark contemporary. An example is found in comparing statements before and after the release of CPI data. Unless there has been something surprising in the outcome, the RBA moves from saying how they are expecting prices to behave to describing that behaviour as reflected in the latest data. That is relevant information, but not a change of view.
Category 3 comments convey a change of view and require closer scrutiny by those seeking to decipher any potential future change in policy.
There are examples of category 3 changes in the February 2016 statement, including:
- Compared with December, the RBA believes the global outlook has deteriorated. Although there’s been continued growth in the advanced economies, this is being offset by conditions in some emerging economies becoming ‘more difficult’. As a result, the RBA’s summary adds that global growth is at “a slightly lower pace than earlier expected”
- Following a more expansive discussion of commodity prices than in December, the RBA reveals a greater degree of concern about financial conditions tightening for the emerging economies. The degree of concern shouldn’t be overstated as the RBA also highlights that “monetary policy remains remarkably accommodative” with funding costs for high quality borrowers still “very low”
- On the domestic side, the RBA reveals a more positive view of developments. December’s view that a “moderate expansion” was continuing has been replaced by the more fulsome statement “that the expansion in the non-mining parts of the economy strengthened during 2015 even as the contraction in spending in mining investment continued”. This is further emphasised by the change from referring to steady unemployment to a decline in the unemployment rate. However, the RBA seems at pains to emphasise that this doesn’t flow into a revised view of the inflation outlook. The February statement is much more detailed on inflation than was December. A brief statement last time has been replaced by a 50-word summary of their CPI forecasting model and the conclusion that “… consumer price inflation is likely to remain low over the next year or two”.
The final step is to decide if they are signalling an overall change of thinking about monetary policy. Remember that the RBA’s process is to base its decision on the combined significance of all the issues summarised in their statement, not to read too much into one or two specifics.
To help us with this, the RBA draws it all together in the last couple of paragraphs of the statement, which more than any others reward close reading.
The first thing to note is that the RBA said once again in February that right at this moment they judge a 2% cash rate to be appropriate. Therefore, they haven’t changed their target rate. This automatically tells us that whatever their changes in view about the economy, inflation and how monetary policy is interacting with those things, no change in policy is required. It will take more changes from the current situation to drive a new policy.
The final comment in the February statement confirms that the RBA Board has a higher level of uncertainty about how things may transpire than in December. Will the labour market continue to improve? Will global turbulence continue and hurt world and domestic growth? In that context they repeat last month’s assurance that “… continued low inflation may provide scope for easier policy, should that be appropriate to lend support to demand”.
To me, all of this is clear: the RBA’s process has resulted in them identifying two new trends, but which are in opposing directions in terms of the economic outlook. These trends do not yet result in an overall change of view about monetary policy. They add to the uncertainty of the outlook and there is a continued sense that if there is a change in future it will be towards lower rates, but the RBA always puts this in the context of inflation being low enough. They can cut rates if needed to support growth without compromising their inflation-targeting objective.
If and when the RBA’s view changes, there will be no magic formula or secret ingredient. The RBA will follow its process and explain their thinking by reference to the same range of factors that they’ve been telling us about for the past seven years.
Warren Bird is Executive Director of Uniting Financial Services, a division of the Uniting Church (NSW & ACT). He has 30 years’ experience in fixed income investing. He also serves as an Independent Member of the GESB Investment Committee. This article is general education and does not consider any individual’s personal circumstances.
This is an edited and updated version of an article that originally appeared as a ‘Bird’s Eye View’ column in the June 2014 edition of KangaNews. Used with permission.