by Michael Witts

What were the reasons behind today's rate decision?

The RBA left the cash rate unchanged at its meeting earlier today. The Bank noted that the transition in the economy has continued and again it is a combination of increased export volumes and strong activity in housing related sectors that are the main drivers of growth.

The Bank has previously indicated that they anticipate interest rates will be on hold for an extended period. There was nothing in the statement from the Bank to suggested that the long period of low rates will come to an end anytime soon.

What is the RBA's reading on the Australian economy?

The Bank is confident in the outlook for the domestic economy, as it believes there is sufficient ongoing momentum especially in light of strong performance of the export sector. It is unclear, at this stage, to what extent the fall in consumer confidence following the budget will translate into retail sales and broader measures of consumer spending.

What is the RBA's reading on the global economy?

According to the RBA, the global economy is continuing to expand at broadly trend pace. However, there are a number of factors just below the surface that  could derail the placid global outlook. These include events in the Middle East; the growth outlook for European economies and ongoing uncertainty in regard to the outlook for China.

In light of the ongoing improvement in the US economy, it is increasingly likely that the Fed will move to further reduce the stimulus it has been providing to markets and eventually move to tighten monetary policy. In these circumstances it is likely that the surplus liquidity be held across the world in non-USD assets will be reversed. This could see a stronger USD and in turn a weaker AUD.

The absence of volatility in global markets is gaining increasing focus from a range of sources, which suggests that a rebound in volatility could be quite sharp and extreme.  

What are the major concerns and what is the RBA's view on the exchange rate this month?

The RBA again re-iterated their recent call that the AUD is overvalued in light of the deterioration in the terms of trade over the past two years. The level of the exchange rate is an impediment to domestic import competing activity; a lower exchange rate would further support the transition underway in the economy.

What is ING Direct's outlook for the economy?

The outlook for the economy is strongly linked with the outlook for market volatility.

In the absence of a return of high levels of volatility, the outlook for the economy is sound. The end result of the budget process is perhaps the largest unknown.

In contrast, event driven spikes in volatility to the extent these disrupt and potentially derail growth in the global economy hold potentially the largest negative impact for the domestic economy.

Notwithstanding these possible outcomes, it appears likely the RBA will remain on hold for a longer period yet; potentially into the first quarter of 2015. A spike in market driven volatility could, subject to severity, see the RBA cut the cash rate in response to global events or at the very least extend the timeframe of unchanged rates further into the future.