At its meeting today, the Reserve Bank Board left the cash rate unchanged at 4.25 per cent.

In contrast to previous months, this outcome was widely anticipated by financial markets.

In an unusual move, the Board telegraphed very clearly their intention at next month’s meeting.

“The Board judged the pace of output growth to be somewhat lower than earlier estimated, but also thought it prudent to see forthcoming key data on prices (due April 24) to reassess its outlook for inflation, before considering a further step to ease monetary policy.”

This is a significant change from the Bank’s commentary in previous months and it is a first for several years where the Bank has forecast so clearly their next policy change.

The Bank recognised that sectors of the economy were under pressure, with the prospect that growth will be somewhat below trend over the year. It appears the Board is gaining confidence that inflation will remain well behaved in the period ahead and not be an impediment to further downward adjustment in the cash rate.

Given this outlook, it could be argued the RBA should have adjusted the cash rate at this meeting rather than waiting the additional month. Sectors of the economy would argue very strongly that this was a missed opportunity.

While global conditions have settled considerably over the first quarter of the year, especially compared with the back half of 2011, the RBA acknowledges that Europe will remain a potential source of adverse shocks for some time to come.

In this regard, unemployment in Spain is estimated at 23 per cent, with youth unemployment at over 50 per cent. Similar statistics are being repeated across several Southern European countries, and it is this aspect that could trigger further social and political unrest, particularly as various countries move into election mood.

Bank funding conditions

The improvement in market sentiment in wholesale funding markets evident in January and February continued into March.

Despite the improvement in funding conditions, the cost of funds remains at elevated levels compared with average levels over the previous 12 months. In this context, it will be interesting to see if banks adjust their rates independent of the RBA.

It should be noted that the move to reprice the asset side of the balance sheet away from RBA interest rate decisions, largely reflects the practice that has occurred on the liability side of the balance sheet for several years. Deposit rates, including term deposits, have been adjusted to reflect banks relative demand for funds measured against competitors.

Regulators are increasingly requiring banks to generate term liabilities, the cost of which is less directly influenced by short-term cash rates. Therefore, it follows that the impact of the cost of longer-term deposits will have an increasing influence on the overall cost of the funding mix.

Impact on interest rates

Despite the above comments, it is unlikely banks will adjust rates this time around. However, if, as appears likely, the RBA reduces the cash rate in May, it may be the case that banks will seek to retain some of the reduction to cover the, still high, cost of wholesale funding.

Investors and depositors continue to be winners

Regardless of future moves by the RBA, and responses by the banks regarding mortgage rates, deposit products will continue to be an attractive destination for investors.

Notwithstanding the improvement in funding conditions in wholesale markets, competition in the retail sector for deposits remains intense.

This is a continuation of trends evident over the past couple of years as banks adjust their funding models in anticipation of the regulatory changes that are on the horizon.

Against this background, combined with the underperformance of both the property and equity sectors over recent years, suggests that a fundamental transformation in asset allocation is underway.

Investors are looking for certainty of attractive returns rather than the uncertainty of could be returns.

This trend will accelerate as the aging of the population dynamic comes increasingly into play.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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