Australia | Feb 19 2008
By Greg Peel
You have to go back to 2003 – November and December to be precise – to find the last time the RBA raised interest rates in consecutive months. Since then all rate increases have been either quarterly or six-monthly as the RBA has tracked along slowly tightening the screws in the booming Australian economy. In 2003 Australia was coming out of a bear market in stocks caused by the US post-tech boom recession. The Australian economy eased, but remained positive, until suddenly China exploded onto the scene in 2004.
The last time the RBA moved rates by 50 basis points, as opposed to 25, was in April 2001 when the rate was lowered to 5.50%. It had already been lowered by 25 points in March, at a time when Alan Greenspan was beginning his now famous easing of US rates down to 1%. Back in the nineties, 50 point moves were all the rage, but interest rates were much higher then.
It has only been in the past few months that the RBA has suddenly realised inflation was spiking in Australia. Not because it was looking the other way, but because inflation had managed to stay within the RBA’s 2-3% “comfort zone” even while China was pushing up the price of every commodity to unheard of levels. The RBA was somewhat surprised inflation had not become worse, but it remained vigilant, and shuffled the rate up quietly. But now inflation has broken through the barrier and those elements which kept it lower (Chinese deflation of manufactured goods, Australians being forced back into the workforce) have run their course.
According to the minutes of the RBA meeting on February 5, released today, staff forecasts had determined that were the RBA to leave rates alone inflation would remain above the target level into 2010. Given domestic demand is only set to intensify in 2008, and the terms of trade are rising and boosting incomes, The RBA was forced to act in February despite the global credit crisis and despite the fact the US is going very much the other way.
In fact, it turns out the RBA was very close to rasing rates a full 50 basis points to 7.25% this month, rather than the eventual 25 points. In the end the bank decided it would settle on 25 points given it could add the other 25 in March.
Given any economic data released in the meantime have been consistently indicative of an economy still booming, a March interest rate increase must now be 99% certain.
ANZ ‘s chief economist Tony Pearson very much expects this to be the case, and expects a further rate rise in May. The minutes all but confirm this as well, assuming nothing particularly devastating occurs in the meantime. Pearson points out the RBA does not even believe its monetary policy is actually “tight” yet. The minutes noted that “the level of cash rate in real [inflation adjusted] terms was noticeably below what might be expected given the economy’s circumstances”. Hence the board considered a “significant” further rise could be necessary.
Which is pretty ominous for struggling home owners, and somewhat of a concern for companies with offshore earnings. If the Fed keeps cutting and the RBA keeps raising, it can only be a matter of time before the Aussie reaches parity to the US dollar.
What could bring inflation under control? Well hopefully rate rises will, as consumers should begin to back off and business lending should start to ease. That’s the idea anyway. Outside of RBA influence a decent recession in the US, causing an easing of the current growth rate in China, may lead to the Australian economy taking a breather as well. But a US recession can only occur if the Fed’s drastic rate cutting plan fails, and the prices of oil and food are just not going down. Nor are the prices of iron ore, coal, and other commodities. Even if the Australian economy did succumb to inside or outside forces, inflation is going to be hard to tame.
It must be noted that the Fed’s plan to keep cutting if it has to is all about rescuing the US economy at the expense of inflation. Already some Fed members are beginning to voice their concerns. Elsewhere in the world, the UK and Canada have both cut rates because they are feeling an impact from problems in the US, while Europe has remained steadfast in not cutting while inflation remains a problem. China is only beginning to realise it has an inflation problem that must be dealt with.
Realistically, the whole world has the same inflation problem.
Special note: the Chinese government announced today the consumer price index rose by 7.1% in January, the most in more than 11 years.