Australia | Oct 20 2009
By Greg Peel
I noted in my review of the minutes of the Reserve Bank of Australia’s September monetary policy meeting that the board was stuck in a juggling act. (See The RBA’s Juggling Act ). On the one hand, inflation was refusing to retreat back into the comfort zone in Australia and the economy appeared to be recovering rather strongly, suggesting the time for an “emergency” rate setting had past. But on the other hand, to raise rates would be to risk choking off that recovery at a time when government stimulus packages were winding down.
There was also a small matter of the Asian economies appearing to be growing strongly, but developed world economies such as the US, Europe and Japan not so strongly. To that end, the RBA suggested in September:
“At the previous meeting [August], members had agreed that if the economy continued to evolve as in the latest forecasts, the Bank would in due course need to adopt a less expansionary policy stance. The information at this meeting suggested that economic conditions were indeed evolving broadly in that way. Nonetheless, some uncertainty remained about the outlook both abroad and at home.”
By October, Australian economic indicators had only become stronger (and this was even before the latest employment data), and to the RBA, this meant “the point had now been reached where the cash rate should be increased”. However, it was still not a lay-down misere. The board still wanted to discuss whether a rate rise in October would still be “premature”. There were two factors weighing on the board’s mind.
The first was the disparity between Asian economic growth and the lack of apparent growth, and ongoing economic uncertainty, in the aforementioned developed world. The risk was that a failure of the net global economy to recover sufficiently would make raising Australia’s cash rate an ill-thought out reaction. It is not stated in the minutes, but clearly the RBA was mindful that it would be the first G20 nation to hike rates. However, the sheer strength of the Asian region and its flow-on effect to Australia meant local issues needed to overcome global issues. This was a vote for a raise.
The other problem was the domestic consideration of whether or not the Australian economy was truly breathing on its own, or whether the oxygen bottle of government fiscal stimulus was still the primary source of recovery. Then there was the small matter of the Aussie dollar, the strength of which was already acting as a brake or “contractionary influence” on economic activity and inflation. While it is not the mandate of the central bank to take exchange rates into consideration except in emergencies, the RBA was mindful that a rate hike would only drive the Aussie higher. These factors were a vote against a rise.
But in the end:
“On the other hand, members judged that, compared with previous meetings, the risks in waiting had increased. In particular, underlying inflation was still, on the latest data, above the target and, while current forecasts suggested it would fall in the coming year, the expected trough in inflation was significantly higher than earlier thought. Keeping interest rates at very low levels for an extended period could therefore threaten the achievement of the inflation target over the medium term. More generally, very expansionary policy could result in the build-up of other imbalances in the economy, which would ultimately be detrimental to economic growth.”
And thus:
“Overall, members concluded that, while downside risks to the domestic economy could not be ruled out, they had diminished significantly over recent months. This meant that the balance of risks was now such that the current very expansionary setting of policy was no longer necessary, and possibly imprudent. The Board therefore decided in favour of raising the cash rate.”
Of course, these minutes are now old news. Usually a close examination of the monthly minutes provides a valuable insight into the RBA’s thinking, such that one might be able to pre-empt the central bank’s next move. But the day after this meeting, Australia recorded a drop in the unemployment rate. For two days in a row, Australia was front page news across the globe. We became the poster children for global recovery.
And RBA governor Glenn Stevens has spoken on more than one occasion since the October meeting, and each time his message has become clearer. The central bank can raise rates further while still providing an accommodative monetary stance – just not an “emergency” stance. The neutral position is considered to be 5%, and that’s a long way off.
In the meantime, the RBA is worried about inflation – both price inflation and asset inflation. While it is the mandate of the central bank to control the former, housing and stock price inflation control is not part of the brief. Australians don’t like the RBA interfering with the values of their properties. But Stevens has recently broken ranks and expressed his concern over rising house prices.
Economists now expect more rate rises to come, possibly 25 basis points in each of November, December and February (there is no meeting in January), and maybe even 50bps in November.
Notably, former RBA governor Ian Macfarlane admitted in a speech last night that he instigated two 25bps rate rises in 2003, when price inflation was benign due to the mild recession, simply given fear about a housing bubble. Of course it became academic, because Chinese growth began to explode from 2004 and rates had to go up anyway.
Read the full October minutes here.