RBA stays its hand

Australia’s central bank sprang a big surprise when it decided to leave the official cash rate unchanged at 4.25% overnight. The statement accompanying the announcement suggested that growth remained close to trend and that underlying inflation was currently around 2.5%, in the middle of the 2-3% target band.

That said, a closer examination of the statement reveals that the RBA is still disposed towards further easing. Global growth expectations for this year have been revised lower, labour market conditions down under are soft, and inflation is expected to decline further over coming months. As the statement confirms:”Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy”. Video:

Strategically, it appears that the board was happy to wait and see, conscious that the US recovery has strengthened over recent months and that Europe’s sovereign debt and banking crisis has stabilised somewhat. Higher equity markets also afforded the RBA the opportunity to further assess the impact of previous policy actions.

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In response to the RBA’s decision, the Aussie jumped to a six-month high above 1.08 overnight, now not that far away from the post-float record of 1.1081 recorded at the end of July last year. It has been an incredibly impressive performance by the AUD over recent weeks. Despite slowing domestic growth and with global growth risk clearly slanted to the downside, the currency has gained more than 10% since the middle of December. Against European currencies it continues to set new records – for example, versus the pound the Aussie is now down to 1.4630!


Greek hiatus hurts the euro. Despite some apparent progress over the weekend, the single currency understandably was on the defensive yesterday in response to the continuing hiatus in Greece. Despite lengthy talks between the leaders of the major Greek political parties over the weekend, no agreement has yet been reached on the stringent demands set down by the troika. The latter has become alarmed by the continued deterioration in Greece’s financial position, insisting that all political parties accept the need for significant additional cuts to government spending and sizeable reductions in wages. Antonis Samara, leader of the New Democracy Party, suggested on the weekend he was not convinced that acceding to the troika’s demands was in Greece’s best interests, claiming he would fight measures that meant the recession in Greece would actually worsen. This was in contrast to a statement from the office of Prime Minister Papademos which claimed that broad agreement had been reached on a variety of measures including spending cuts worth 1.5% of GDP, a boost to funding for social security and various competitiveness initiatives. Particularly contentious are the troika’s demands that private sector wages be lowered by more than 15% and the call for further significant layoffs in the public sector. Interestingly, it appears that Greek politicians have not even reached the point where they have commenced discussions on these wage and jobs demands. All this needs to be agreed very shortly given that Greece does not have the money available to pay for the EUR 14.5bln bond redemption on March 20th. The Eurogroup has said that it will not consider lending Greece any more money until the country’s politicians agree to the troika’s demands. Because of the rapidly worsening fiscal position in Greece, the size of any new bailout may be closer to EUR 145bln, up from the initial estimate of EUR 130bln.

EU Commission impatience with Greece. No one is any doubt that the EU Commission lost patience with Greece long ago. Even so, some of yesterday’s headlines on the subject were compelling – “Greece is beyond deadlines”, the Commission wants the talks concluded “now”, there is “a backlog in the implementation of austerity measures”, and the Eurogroup is ready to meet as soon as these commitments are made. As the old saying goes, there are two hopes – Bob Hope and no hope – and right now it is looking hopeless.
The UK funding gap. The focus now is naturally on whether the Bank of England will sanction more QE at this week’s MPC meeting, but there are other issues that the Bank should be thinking about at this point in time. What has been notable in the money markets is the contrast between developments in sterling markets compared to the dollar and the euro’s. More specifically, whilst Libor-OIS spreads have been steady to slightly wider for sterling (essentially measuring the premium attached to unsecured interbank lending), they have been falling for both dollars and euros. The spread for euros moved above that for sterling in the middle of last year as the eurozone sovereign debt crisis really began to bite. Indeed, the gap between the two was as wide as 40bp towards the end of last year. Now it’s just over 10bp. Of course, the injection of 3yr cash from the ECB in December played a key part in the fall of the Libor-OIS spread for euros, but more to the point is the fact that the sterling equivalent has not fallen at all over this period. At the same time, UK banks have around GBP 140bln of term funding due to mature this year, with the majority of this occurring in the first half of the year. There has also been evidence (as mentioned in the BoE’s latest Financial Stability Report) of the duration of short-term funding falling most significantly for UK banks, which increases the roll-over risk. The Bank’s special liquidity facility, which officially ended at the end of last month, was introduced back in 2008 as a way for banks to swap high quality assets for UK Treasury bills. Furthermore, the BoE appears keen for UK banks to sort their own balance sheets out, as was detailed in December’s Financial Stability Report. Quantitative easing can only go a small way towards improving the short-term funding strains, for instance by increasing asset values. We doubt that the Bank will introduce a new scheme, or alter existing facilities, to improve the liquidity position of UK banks, but the issue should be on its radar for this week, especially given the contrast with the eurozone market.

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