Australia | Sep 29 2010
By Greg Peel
Reserve Bank of Australia governor Glenn Stevens believes Australia is set to “experience the largest minerals and energy boom since the late nineteenth century”. Strong stuff.
There are those who may disagree with Stevens, or at the very least will suggest the road to China and India's emergence as global economic superpowers will be a bumpy one and hence not something simply to be taken for granted. But for Stevens, the challenge is to make monetary policy settings with foresight rather than hindsight. So often central banks respond anxiously to immediate economic data, and hence often, as it is lamented, central banks are accused of going “one step too far”.
Perhaps an obvious example was the RBA's decision to raise its cash rate to 7.25% in March 2008 in response to strong commodity prices which were really only a factor of a weak US dollar. This was the last step in the run from 4.5% in May 2002. Bear Stearns was just about to be rescued – a butterfly flap which six months later would end in the Lehman tsunami. The Fed had already cut from 5.25% to 3.25% over six months and would soon move to zero. After Lehman, the RBA was forced to cut aggressively down to 3%.
Indeed, by August 2007 it became apparent something was very wrong with the US financial system. The Fed began to cut in September but the RBA hiked in August, November, February and March. China was definitely buying commodities back then, but that was not really why oil had exploded through US$100/bbl. Australia's core CPI had moved out of the RBA's comfort zone, but the indicators proved misleading.
Not that any central bank can be blamed for having a foggy crystal ball. The bottom line is that problems are best considered on a medium-term basis rather than a short-term basis such that policy settings can be less staccato and more legato. Smoother interest rate moves make for a more stable economy.
At least until the last policy meeting early this month, the RBA has been constrained by the goings on offshore. Having returned the cash rate to a “neutral” 4.5%, one feels the board has been champing at the bit to raise before the comfortable underlying inflation rate of 2.7% ceases to be comfortable in the face of rising Chinese commodity demand. But with Europe potentially still a sovereign debt house of cards, and the US economy threatening to contract once more, the RBA would be having flashbacks of 2008.
Stevens must now be feeling like King Canute. With Australia' GDP growth rising faster than expected and unemployment almost down to “full employment” levels, the spare capacity in the Australian economy that was created by the GFC is all but gone. And idle factories and unemployed workers are the only things standing between a runaway terms of trade and a pent up capital investment pipeline, and an inflation explosion.
It is possible that the RBA will wait one more month to see how things play out offshore, by which time the third quarter consumer price index data will be in. A jump there would make a November rate rise a given. All CPI movements have been downward to date since the GFC hit in earnest. But the economists at the ANZ believe Stevens will prefer to be pre-emptive this time and move in October (next week in fact). And then the RBA will move again in November.
A total of 50 basis points will, in ANZ's eyes, provide a pre-emptive, restrictive setting that prepares Australia for what is to come in 2011. By end-2011, ANZ expects the RBA will have hiked to at least 5.5% and maybe even 6%. By flowing with the tide now at least to some extent, the RBA will avoid suddenly having to implement hike after hike after hike consecutively in 2011, on the assumption inflation pressure continues to build. It is those sort of hiking periods which set the average Australian right back on their heels. As ANZ points out, the RBA has to make its decisions “in the presence of high levels of household debt”.
Were the RBA to act pre-emptively, it leaves more space to be flexible in 2011. The central bank was caught out by a lagging inflation effect in 2008 which appeared to be constrained before bursting up to 4%. The RBA then responded with rapid rate hikes only to hit a GFC. Had the central bank shifted policy settings a little earlier, then perhaps the final hikes could have been avoided before they had to be rapidly withdrawn.
A pre-emptive hike in October would demonstrate the RBA is thinking medium-term this time, suggests ANZ. “To move rates early,” says ANZ, “is to move rates less over the course of the cycle”. Legato.
ANZ expects the benefits of the current commodity export boom to filter through to the broader Australian economy for years to come. The economists expect GDP to accelerate at above trend rates in 2011 and 2012. Only in 2012 will investment growth peak and the unemployment rate trough. Core inflation (ex food, energy and other volatile items) will peak at 3.2% in mid-2012 according to the ANZ forecasts.
That is not to say the RBA will now move to a policy of ignoring immediate economic data. Were the data in October (post the first hike) to be not as strong as anticipated, November may yet see another halt, says ANZ. And there are other factors to consider.
The first is bank funding costs which, since the European debt crisis, have risen again. It had been anticipated that the banks would likely make independent mortgage rate hikes immediately after the election, once the threat of campaign attacks had gone. But despite the election result taking somewhat longer than usual, the banks still have not moved. Is it because the new minority government is so unstable it may yet implode, meaning the banks are still frightened of upsetting the electorate? Or is it because the banks believe (as ANZ does) that the RBA will hike next week, providing “cover” for greater than 25 basis point SVR jumps?
Either way, it is quite possible the banks will raise lending rates by a greater margin than the RBA, thus reducing the RBA's need for further immediate hikes. Independent hikes are themselves restrictive, and so is a strong currency – the other factor.
The strong Aussie dollar will impact directly on Australia's export industry with the possible exception of, ironically, the commodity export sector. What the resource sector loses on the swings of a strong Aussie it may well gain on the roundabout of higher USD commodity prices. But if a stronger Aussie is acting as a dampener on growth of other export and foreign currency revenue-based businesses, then cash rate hikes will not be as imperative.
