FYI | Apr 04 2007
The last time the Reserve Bank of Australia raised the official cash rate in Australia was in November last year when the “interest rate” went up by 25 basis points (0.25% ) to 6.25%.
What this means is that according to the central bank’s own in-house modeling, the Australian economy is still digesting the last two hikes. It is the RBA’s assessment that on average every rise by 100 basis points (1.0% ) in the cash rate cuts circa 1.3% off GDP growth while reducing inflation by 0.4% over three quarters.
According to these assumptions, Australian consumers and producers are still feeling the impact from last year’s August tightening. It will be a few more months still before the economy will have fully digested the November rate hike.
No wonder thus half of the country’s population of economists remains convinced inflation risks should subside in the months ahead, even if the RBA would decide to stay on hold throughout the rest of the year.
What the RBA model clearly highlights as well is how much more difficult it is for a central bank to tame run away inflation as higher interest rates hit so much harder on economic growth.
Developed countries such as the US and Australia don’t grow at rates of 9% and beyond like China and India do. Cutting GDP by 1.3% to only reduce inflation by 0.4% can easily turn out disastrous under the wrong circumstances.
So did the RBA make the correct decision this week by leaving interest rates at 6.25%?
The answer lies partly in how far the central bankers want to move in their pre-emptive approach. The question was always: should the RBA wait for another inflation survey or not? The answer, post the April 3 board meeting, appears to be “yes”.
At least that’s what we on the outside think we can deduce from this week’s decision. We don’t know anything with any certainty because the RBA has a policy of minimal disclosure. We are not even allowed to know who voted what at these meetings.
For what it’s worth: I think the RBA should provide investors and other Australians with a fuller disclosure about what happens at these meetings. In countries such as the US and the UK the market’s view on the direction of interest rates is often influenced by the balance during the voting process at the central bank, or by comments made during the debate that precedes it.
In Australia all what goes on behind RBA doors remains hidden from the outside, guided, in my view, by an antiquated, patronising reflex that lifts RBA policy makers to the status of “untouchables”. Alas, I cannot see any genuine merit in keeping the current policy of secrecy intact. I think the RBA should modernise and abandon this antiquated legacy.
I know they won’t, but I still wanted to make that point, regardless.
The RBA has decided not to pre-empt inflation at a time when concerns about creeping up inflation are bound to resurface anytime soon. Crude oil is back in the mid-US$60s and even though more or less tension in the Iran-UK conflict is causing heavy price swings, a good deal of market experts had been flagging this price level already without the conflict.
This raises an interesting question: how quickly will oil bounce back after the inevitable drop that will follow the diplomatic solution between Iran and the Blair government? Or maybe not at all?
The markets still take a lot of their guidance from signs of economic strength, or weakness, in the US. But it is of course China that will keep prices of oil, and of base metals and other commodities elevated in the months ahead.
Again, most experts in the West have been underestimating the underlying power of the Chinese economy. Asian specialists at Credit Suisse concluded this morning the odds are again in favour of Chinese growth surprising on the upside this year. They foresee more tightening by Chinese policy makers and more attempts to otherwise reign in inflation later this year.
Credit Suisse has increased the country’s GDP forecast to 11% for this year, and this includes the prospect of further tightening measurements. Current market consensus is for Chinese GDP growth this year below 10%. As you would expect, the Asia specialists believe the broader market will have to catch up with reality at some stage.
While economists are bound to start fretting soon about how rising prices for nickel, copper and crude oil (et al) are bound to translate into higher consumer prices (inflation), there might be another change happening which hasn’t received much attention just yet. However, if the early signs prove to be correct, we are going to read a lot about this in a few months from now: China no longer exporting price deflation.
Analysts at GaveKal had a meeting with management at Li & Fung recently. Although the name doesn’t ring a bell for most of us, this is one of the biggest trading firms in the world. GaveKal reports Li & Fung management highlighted deflationary pressures from China are abating rapidly.
It’s early days still and the scenario of China no longer keeping global inflation contained has been suggested a few times last year already, but without any merits. It is rather unlikely this will lead to major headlines in the weeks ahead.
It will also remain very much dependent on how strong economic growth outside China will turn out in the second half of this year.
And that is exactly the question that will remain on the minds of the RBA board members.
Till next week!
Your as ever forward looking editor,
Rudi Filapek-Vandyck
(as always supported by Terry, Chris and Greg)