Australia | May 06 2008
By Greg Peel
Here’s the statement which accompanied today’s decision to leave the cash rate at 7.25%. I’ve added the emphasis:
“Inflation in Australia has been high over the past year, with the CPI rising by a little over 4 per cent and underlying measures at a similar pace. Price rises were widespread, in an environment of limited capacity and earlier strong growth in demand.
“In order to reduce inflation over time, growth in aggregate demand needs to be significantly slower than it was in 2007. Evidence is accumulating that this is occurring. Indicators of household spending have recorded subdued outcomes over recent months, and demand for credit by both households and businesses has weakened.
“As a result of the Board’s earlier decisions, additional rises in market interest rates and tougher credit standards for some borrowers, there has been a substantial tightening in financial conditions since the middle of last year. Conditions in international financial markets, though improved in recent weeks, also remain difficult. These factors are acting to restrain demand.
“The rise in Australia’s terms of trade currently occurring, which is larger than had been expected a couple of months ago, will work in the opposite direction. It will add substantially to national income and ability to spend, even with the slowing in global growth to below trend pace that the Bank has been assuming for some months now.
“Given the opposing forces at work, considerable uncertainty remains about the outlook for demand and inflation. On balance, the Board’s current assessment is that demand growth will remain moderate this year. In the short term, inflation is likely to remain relatively high, but it should decline over time provided demand evolves as expected. Should demand not slow as expected or should expectations of high ongoing inflation begin to affect wage and price setting, that outlook would need to be reviewed.
“Weighing up the available domestic and international information, the Board’s judgement is that the current stance of monetary policy remains appropriate for the time being. The Board will continue to evaluate prospects for economic activity and inflation in the light of new information.”
Other than the specific reference to the 4% CPI from the first quarter, which was largely assumed but unknown when the board had its last meeting in April, the first three paragraphs of RBA governor Glenn Stevens’ statement this month is mostly a repetition of last month’s: Demand needs to be lower, and the evidence suggests this is happening; household and business credit demand is weakening; domestic conditions have tightened given previous rate hikes; and international conditions remain difficult.
It is in the fourth paragraph we begin to vary. Last month Stevens noted, “Notwithstanding some recent declines in world commodity prices…a further large rise in Australia’s terms of trade is in prospect this year“. (Again, my emphasis). It seems now, however, that that “further large rise” is suddenly upon us. It is “larger than expected” and will “add substantially” to spending “even with” slowing global growth.
This means those evil opposing forces are at work. Thus in the next paragraph, suddenly “considerable uncertainty remains”. This is new. Stevens reiterates his belief that inflation “should” nevertheless decline, but now he warns that if demand doesn’t slow, or if inflation shows up in higher “wage and price setting” (which includes therein a shot at the unions under a new non-AWA Australia) then “that outlook would need to be reviewed”.
It is a clear warning. “You have gotten away with it this time, Australia, and you may yet continue to get away with it, but don’t think we won’t be watching you like hawks”. (Ahem…pardon the pun).
Stevens then wraps up with the standard tag of continuing to “evaluate prospects”.
All bets, it would appear, are off. It’s now all down to the data. Given that Australia’s official inflation measurements are only made quarterly, and not monthly, one presumes we may get a reprieve through to August, which is when the Rudd tax cuts will be in play. However, if credit demand fails to show sufficient signs of falling and/or the terms of trade accelerate further between now then, it may yet be touch and go. If the CPI did not peak in Q1, but pushes higher still in Q2, then another rate rise is the likely result. It’s a balancing act.
As for the next cut, we can talk about that some other time in the rather distant future.