What were the reasons behind today's rate decision?

The RBA left the cash rate unchanged at 2.5%. This outcome was widely expected, however in contrast to several recent months, the RBA highlighted a number of matters that were contributing to a clouded outlook for the period ahead.

In particular, the RBA called out the acceleration in the rate of decline in the price of key commodities - the slide in iron ore prices has accelerated over recent weeks.

Reflecting the most recent decline in commodity prices, the AUD has lost a further 300/400 points over the past few weeks. The RBA would be pleased with this outcome as this will assist various sectors of the domestic economy. The fall in the currency may mitigate any near-term reduction in the cash rate from the RBA.

Despite the weakness in commodity prices, activity in the housing sector remains strong and continues to underwrite domestic activity.

What’s the outlook for the cash rate in 2015?

In contrast to recent months, the answer to this question is less clear cut than previously has been the case.

The lower currency is likely to mitigate the need for a near-term decrease in rates, as the lower exchange rate has a stimulatory impact.

The events in commodity markets over the past six weeks need to be seen in context. The price of oil has responded to oversupply concerns as increased shale oil out of the US, together with unchanged OPEC production, floods the market in an attempt to pressure marginal high cost producers. To a certain extent a similar picture emerges in relation to base metals. Putting economic considerations to one side, there appears to be a supply glut aimed at eroding the position of marginal producers.

To further encourage balanced growth, China surprised markets by lowering their interest rates, while this may be seen as a negative factor , it will provide for further growth in that economy which will benefit the outlook for Australian exports.

The US economy continues to perform strongly and this will likely lead to the US Federal Reserve increasing rates in the first half of 2015.

Against this backdrop, the RBA is expected to keep cash rates on hold for an extended period.  It will largely be a function of the timing of US rate movements that will provide scope for the RBA to move on Australian interest rates.

To the extent that the AUD continues to move lower, the need for any rate reduction in the Australian market is pushed into the background.

Has the RBA’s view on the economy changed since the beginning of 2014? How has it changed?

To the extent that the RBA has left the cash rate unchanged throughout 2014, it can be argued that the RBA’s view on the economy has not changed over the year.

The RBA would have expected that the exchange rate would have been more responsive to lower commodity prices and as such provided greater stimulus across the economy to offset the decline in investment spending. As a result, the housing sector has carried a greater burden for growth in the economy. If the exchange rate had been lower, it could be argued that the RBA would have moved the cash rate to address emerging imbalances in the housing market. Instead, it appears that APRA is likely to introduce measures to curb the level of housing investment lending, which will act to take some heat out of this segment of the market.

What are the main concerns for the RBA going into 2015?

The RBA’s concerns are largely unchanged over the past few months. In summary these are:

  • Unbalanced global growth - weak European and Japanese growth, offset by strong growth in the US and to a lesser extent China.
  • Domestic growth below trend with unemployment rates higher than desirable.
  • A lower exchange rate is required for a longer period to be able to achieve balanced economic growth.

What is the RBA’s view on the lower Australian dollar?

As noted previously, the RBA would still like to see the AUD respond more strongly to the drop in commodity prices. However, this traditional nexus has weakened as the AUD has increasingly become a reserve asset that is held regardless of either the level of interest and / or exchange rates. This is a new dynamic that the RBA and the market must contend with in the period ahead.

What is ING DIRECT’s outlook for 2015 for the Australian economy and the Aussie dollar?

The weakness in the AUD is to be welcomed as it provides a stimulus to the economy beyond housing related sectors. Although domestic growth may be slightly lower than expected, the export sector continues to contribute strongly to overall growth.

In this scenario it is difficult to see the RBA looking to move the cash rate lower in the period ahead. Indeed the risk clearly remains that the next move will be higher, although the timing is perhaps moving clearly to around, if not beyond, mid-2015.

The commodity markets are being driven by a range of factors that do not necessarily align with economic growth driven supply and demand considerations. As these factors wash through, the markets fundamentals will prevail and commodity prices should recover slightly from their current sharply lower level.