Interest Rates: RBA Sits, Sees No Need To Cut

The Reserve Bank left its cash rate steady at $4.25% yesterday for the very good reason that there was no need to cut it.

The decision is bad news for the banks, for bank investors (aren't we all!), but good for retirees and good for depositors, and those on fixed incomes.

For those with home loans, it won't really impact because the banks would have pinched all or some of the cut.

And besides, over 50% of mortgagees are repaying their loans faster than they have to.

The dollar jumped on the news, rising about one US cent to $US1.081 - a six-month high - within minutes of the RBA's announcement at 2.30 pm.

It also touched fresh records against the euro and hit a 27 year-high against the pound.

The dollar later fell back around one US cent to around $US1.075.

The news saw the Australian stockmarket fall after drifting slightly higher ahead of the statement. Markets in Asia were lower on concerns about Greece and the eurozone.

As suggested yesterday the bank decided that the current level of activity in the Australian economy was sufficiently strong enough not to need a third rate cut for four months.

And there's no sign of any further cuts, unless Europe tanks, or the local economy weakens, dragging inflation even lower than the current level of around 2.5% (on the RBA's core measures).

The key to the bank's thinking was, as usual, found in the final paragraph of today's statement from Governor Glenn Stevens:

"The Board noted that interest rates for borrowers have declined to be close to their medium-term average, as a result of the actions at the Board's previous two meetings.

"With growth expected to be close to trend and inflation close to target, the Board judged that the setting of monetary policy was appropriate for the moment.

"Should demand conditions weaken materially; the inflation outlook would provide scope for easier monetary policy.

"The Board will continue to monitor information on economic and financial conditions and adjust the cash rate as necessary to foster sustainable growth and low inflation."

The move means the banks and especially the big four are stuffed, if you believe their moaning and groaning in recent days about whether they will pass on all or none or some of the much tipped cut, which didn't happen.

Watch for the banks to talk (through selected mates in the media and the analysts) about more job losses and the need to cut costs, without explaining that costs are not the problem, it's the low revenue growth, as the RBA figures each month on private credit growth tell us.

Home lending is at a 34 year low, business lending is weak, other personal lending is falling: it's tough for the banks to grow revenue and profits.

So while the weak income growth is eroding profit margins from one side, the rise in offshore funding costs is cutting them from another.

The strong dollar is also hurting, reducing the Australian dollar amounts of the US dollar and euro-denominated borrowings from offshore lenders.

On the local economy, the RBA Governor said in yesterday's statement:

"Information on the Australian economy continues to suggest growth close to trend, with differences between sectors.

" Labour market conditions softened during 2011 and the unemployment rate increased slightly in mid year, though it has been steady over recent months.

"CPI inflation has declined as expected, as the large rises in food prices resulting from the floods a year ago have been unwinding.

"Year-ended CPI inflation will fall further over the next quarter or two. In underlying terms, inflation is around 2½ per cent.

"Over the coming one to two years, and abstracting from the effects of the carbon price, the Bank expects inflation to be in the 2-3 per cent range.

"Credit growth remains modest, though there has been a slight increase in demand for credit by businesses.

"Housing prices showed some sign of stabilising at the end of 2011, after having declined for most of the year.

"The exchange rate has risen further, even though the terms of trade have started to decline. This is largely a reflection of a decline in the euro against all currencies.

"Nonetheless, the Australian dollar in trade-weighted terms is somewhat higher than the Bank had previously assumed."

And judging by the number of mentions in yesterday's statement, Europe remains the central bank's biggest worry, as it has since last October onwards.

But even there, there's a noticeable change in thinking.

"Information becoming available since the December meeting confirms that economic conditions in Europe were weakening late last year, with risks still skewed to the downside.

"Reflecting this, most forecasters have lowered their forecasts for world GDP growth this year to a below trend pace. That said, recent data from the United States suggest a continuing moderate expansion after a soft patch in mid 2011.

"Growth in China has moderated as was intended, but on most indicators remained quite robust through the second half of last year.

"Conditions around other parts of Asia have softened.

"Commodity prices declined for some months to be noticeably off their peaks, but over the past couple of months have risen somewhat and remain at quite high levels.

"The acute financial pressures on banks in Europe were alleviated considerably late in 2011 by the actions of policymakers.

"Much remains to be done to put European sovereigns and banks on a sound footing, but some progress has been made.

"Financial market sentiment, though remaining skittish, has generally improved since early December.

"Share markets have risen and term funding markets have re-opened, including for Australian banks, albeit at increased cost compared with the situation prevailing in mid 2011."

The statement doesn't mention it, but don't forget March 20: that's when Greece has to redeem a 14.5 billion euro loan. That's the date to worry about.

The current negotiations (more were due overnight) are rattling around as the horse trading between the Greeks and their lenders, especially the EU and the IMF, continue.

Hopefully there will be agreement and then the EU finance ministers will sign off on the deal (a meeting could happen on Thursday and Friday). If not, more talks and the tension starts rising.

So we are not out of the woods by a long way. But if Greece does default and fear and loathing return to markets, remember that we are better placed in Australia than Europe is. And so is China.