For the second month in a row the RBA board decided to boost the recommended interest rate cut from the original recommendation. In November, however, there was a small but important difference.

For the first time in a long time, the Reserve Bank was left with a decision to cut rates by one of two amounts: 0.50% or by 0.75%. At the October meeting when the original recommendation was for a 0.50% cut, Governor Glenn Stevens arrived at the meeting with a new recommendation for a 1% cut after credit and other financial markets went into near meltdown.

The minutes for the Melbourne Cup Day meeting on November 4 make it clear that Governor Stevens and his executives had again recommended a half a per cent cut, subject to review of developments between the preparation of that recommendation and the board meeting:

The paper prepared for the Board recommended a further easing of monetary policy, suggesting a reduction in the cash rate of 50 basis points, with the amount to be subject to review in light of any further information becoming available between the preparation of the paper and the time of the meeting.

At the meeting, the Governor proposed that members consider the choice between a reduction of 50 basis points and one of 75 basis points.

That was different to what happened in October when the minutes recorded this:

The paper prepared for the Board recommended a large reduction in the cash rate, of at least 50 basis points, with the amount to be subject to review in light of any events occurring between the preparation of the paper and the time of the meeting. In the event, the recommendation put to the Board at the meeting was for a reduction of 100 basis points, to 6.0 per cent.

And what new information emerged from the end of the previous week, when the board papers were sent to members and November 4? The ABS stats on November 3 showing a 1.1% fall in retail sales in September and the house price index for the September quarter fell by 1.8% across the eight capital cities in the survey, which was the sharpest fall for some time. And markets remained nervous, with a credit freeze in place.

So it pays to look at and examine the information flow just before an RBA board meetings in turbulent times. That was the same as in October when the volatility in financial markets surged in late September/early October as markets absorbed the impact of the Lehman Brothers collapse and a spate of bailouts in the US and Europe.

The November 4 cut of 0.75%, to 5.25% for the cash rate, took the market by surprise for a second month in a row and has led to conspiracy theories among some market commentators and economists who claimed that it was done deliberately to wrong foot the market and to “give” a bigger than expected cut

In fact for the second meeting in a row, the board heard that the financial markets had full priced in a cut of 0.50%:

Members noted that market expectations were for the cash rate to reach 4–4¼ per cent in the first half of 2009. Market pricing indicated that, for the current meeting, a fall of 50 basis points had been fully priced in, with a significant probability of a 75 basis point move.

So the board was left to make the choice, which it did by following what the market had been pricing in.

And the justification:

Members agreed that a further sizeable reduction in official interest rates was appropriate. This would enable a further meaningful reduction in rates paid by borrowers and could assist confidence among consumers and businesses. In addition, given the changing balance of risks, there was an advantage in moving the setting of monetary policy quickly to a neutral position.

On balance, members judged that a reduction in the cash rate of 75 basis points was appropriate on this occasion. Members were conscious of the high rate of inflation at present and of the need to bring it down over time, but felt that in the current environment a reduction of this size would not undermine that task.

The market now has a 0.50% cut priced in for the December 2 meeting, but there’s a chance, once again of 0.75%, according to the futures prices. The justification this time is the bank will need a cut for January because there’s no meeting. So watch for a 0.50% cut and perhaps a January special meeting? Rory Robertson of Macquarie Bank reckons that’s a more than reasonable bet.

Peter Fray

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