RBA "tone" index returns to neutral--and UBS call August pause

Fascinating research from Matthew Johnson and Andrew Lilley at UBS, which is more in line with my long-held, non-consensus priors that the economy is fine in contrast to many who have claimed that its been growing at a significantly sub-trend pace (if I am correctly bullish in this context, then so be it):

At the margin, the RBA was more upbeat than we had expected, returning our ‘tone’ measure to neutral...It is easy imagine the RBA on hold in August. Their present stance appears to be data-dependent, so they will likely need weak data to drive further easing. Given the better than expected Q1 GDP report, and the recently improved tone of interest rate sensitive sectors (house prices, retail sales, building approvals, car sales), core inflation ~0.7%q/q seems pretty sure to see the RBA keep their policy rate steady at 3.5%.

Looking broadly, the available June data suggests some loss of momentum, following a robust April and May1. More encouraging, however, our leading indicator has recently picked up (due to credit growth and building approvals).

Policy works with a lag, so the monetary easing that’s been delivered so far has more to give. In combination with the (temporarily) expansionary stance of fiscal policy – due to the front loading of 2012-13 payments into Q2’12 – it is possible that demand will firm somewhat in the short term, and that this will give the RBA time to hold at 3.5% and gather more information.

If we are correct in this judgement, the short end is likely to sell off ~35bps, taking the one year ahead implied easing to ~50bps, from the present ~85bps. We look for RBA Deputy Gov Lowe to provide encouragement in this direction, when he speaks on Wednesday and Thursday.