The RBA may hold due to a weaker dollar

The Reserve Bank of Australia is scheduled to hold a monetary policy meeting on Tuesday, at which the board will determine what the official cash rate will be. In response to weak global economic conditions, falling asset prices and other negative influences on domestic growth the RBA lobed 200 bps of the official cash rate in only 19 months, bringing it to its lowest ever level of 2.75%. Recently, some of those pressures have eased as global sentiment has improved.

The decline in the value of the Australian dollar has been broadly positive for the Australian economy, although the positive impact in parts of the economy has been offset by falling commodity prices and weakness in Australia’s largest trade partner, China (official and private sector manufacturing PMI figures for June are due out on Monday, with 50.1 and 48.3 expected respectively). Nonetheless, global funding conditions have improved for Australia’s banks, balancing most of the negative impacts from lower rates domestically. There have also been signs of strength in Australia’s housing market and the labour market. This combination of positive factors and the fact that we haven’t seen a significant deterioration in domestic data (Q1 GDP was slightly below expectations at 0.6% and home loans for April also missed expectations, but the unemployment rate unexpectedly dropped to 5.5%) or global sentiment since the bank last met may be enough to keep the RBA on the sideline next week.

Another cut may be on the table later in the year

However, we aren’t ruling out another rate cut later this year. Offshore, sings of weakness in the heart of China’s economy cast doubt over the future export demand for Australian resources and the outlook for the Eurozone remains bleak. Domestically, the effects of prior rate cuts are yet to really find their way into the real economy. While there have been indications that some sectors of the economy are responding to the RBA’s recent easing cycle, there isn’t yet the broad positive flow-on effect that we would expect to see from such extreme monetary policy loosening. Hence, it is hard to envision a smooth transition away from mining investment when non-resources sectors of the economy are struggling to pick up the slack.

The Aussie

Current market pricing suggests that the chance of a rate cut on Tuesday are low, thus the impact on the Aussie may limited if the bank remains on hold. However, the market will be closely watching Governor Stevens' statement for indications about future policy decisions. If the bank loses its easing bias, then we may see a relief rally in the Aussie.