After two straight months of rate cuts, the RBA held rates steady; a reflection of increased market optimism and moderating financial pressures on European sovereigns and banks.
T he RBA left the cash rate unchanged at 4.25%. Governor Stevens’ tone has become much less dovish than at the December meeting but policy continues to be focused on external factors: the Chinese economy and European sovereign and bank worries. Over the past two months, market expectations of rate cuts have moderated by roughly 50 bps, however 75 bps of rate cuts over the next 12 months is still priced in.
We continue to be apprehensive of these expectations and believe they are overdone. However, longer-term spreads versus the U.S. (and therefore yield levels) are likely to remain range-bound even as policy expectations may be unwound. On the domestic front, the RBA stated that the Australian economy’s growth is near trend, inflation is nearing its target range and borrowing rates are hovering close to their medium-term average as a result of the rate cuts in the last two months of 2011.
In short, the RBA seems satisfied with the pace of current growth. Barring any major shakeup in the European debt crisis or a hard landing in China, we expect the RBA to remain on hold.
Our Global Fixed Income Strategy service continues to recommend a neutral weight for Australia in a hedged global bond portfolio. Signs of a hard landing in China would prompt an overweight allocation.