Reserve Bank deputy governor Philip Lowe's remark on Tuesday night that the central bank had room to cut its cash rate further if it needed to was the last official word on rates before the bank's board announces its next rates decision on Tuesday.
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The pre-meeting ban on Reserve Bank comment about rates began on Wednesday afternoon, when its top executives sat down to frame their recommendation to the board.
Lowe's comments added to the sense that the lie of the land is subtly shifting, however: the Reserve has had its cash rate at 2.5 per cent since August last year and won't move it on Tuesday, but the markets are now hedging their bets about how much longer its "period of stability" will last.
Lowe's comments were made after his speech on Tuesday night. Rate cuts worked through what economists called intertemporal substitution, he said: they pulled spending people would do tomorrow into today.
The mechanism required that people borrow, however, and in key northern hemisphere economies "people don't want to borrow – they've had enough". It was an issue in this economy too, he said, but if the Reserve wanted to cut rates it could. "Lower interest rates would be stimulatory," he said.
Lowe also said in his speech that the Reserve still believed that sharp declines in the prices of key commodities warranted further declines in the value of the Australian dollar that would spur economic growth.
The Australian dollar was about US86.7¢ when he spoke, down from almost US94¢ early in September. It went as low as US85.1¢ after his comments, and was trading about US85.5¢ early Wednesday evening.
Other factors fed into the dollar's slide. US economic growth in the September quarter was also upgraded on Tuesday night, for example, from an initial estimate of 3.5 per cent to 3.9 per cent, well above a market estimate of 3.3 per cent.
The US economy also expanded by 4.6 per cent in the June quarter. The two quarters combined represent the best growth spurt in more than a decade, and our currency's weakness is in part a reflection of US dollar strength, in anticipation of US interest rate rises next year.
I should stress that Lowe also spoke positively at length about this economy's strengths, and about ways to lock in sustainable long-term growth. The Reserve has promised that it will start talking about changing interest rate settings well before it actually does anything.
It also still believes the Australian dollar is too high, however, and a rate cut would do two things: pull the dollar down, and directly boost an economy that outside the housing sector is struggling to fill the hole left by a mining investment boom that the Bureau of Resources and Energy Economics confirmed on Wednesday was grinding to a halt.
The currency impact would be even greater if interest rates went down here next year as US rates headed up, narrowing the interest rate premium that Australia offers.
How likely is the rate cut scenario? Still less likely than one that has rates on hold for an extended period, but the markets are beginning to hedge their bets. Credit Suisse says that a few months ago interest rate swap prices were predicting that the Reserve would start raising the cash rate in the middle of next year. They are now pricing in a 40 per cent probability of a rate cut by August.
Credit Suisse's own interest rate model is pointing to a cash rate cut of one and a half percentage points during the next year. Leading economic indicators including low confidence and inflation expectations are consistent with weak growth in Australia, it says, and "suggest that a case can be made for further cuts".
Alliance Bernstein also says there is a growing prospect of a rate cut. Goldman Sachs has cut its estimate of economic growth here next year from 2.3 per cent 2 per cent, and listed a rate cut in the first half of 2015 as a "high probability" even as it maintains its base case that rates will be on hold throughout 2015.
The OECD went the other way on Wednesday and called for rate rises here from mid-2015, to temper a housing boom that Lowe said on Tuesday night needed to be leant on rather than crushed.
It also maintained a prediction that the economy would grow by only 2.5 per cent in 2015, however. The lower dollar is a boost but that doesn't sound like a platform for rate rises to me.
