Australia | Nov 02 2010
By Greg Peel
In the statement accompanying the RBA's October monetary policy decision, in which the cash rate was kept at 4.5%, RBA governor Glenn Stevens told us:
“If economic conditions evolve as the Board currently expects, it is likely that higher interest rates will be required, at some point, to ensure that inflation remains consistent with the medium-term target.”
The Board has been expecting that given the effect of Australia's strong terms of trade (commodity boom) it can only be assumed that Australia's inflation rate will now begin to turn around from its previously falling trend. Having been caught out in 2008 by a very sudden such turnaround, the RBA has been hinting that this time it would move to quell those pressures before they get out of hand.
That's the reason why economists have long been expecting at least one rate rise this year or, if not, rate rises into 2011. But as to whether the “at some point”, as suggested by Stevens in October, should come right now or a bit later has been a matter for debate. The question is: have economic conditions “evolved”, as the Board expected in early October, through the month?
The short answer is no, if you go by the data. The RBA's measure of inflation actually dropped again in the September quarter and yesterday's private sector credit demand data were weaker than expected. House prices have stalled, and the Aussie dollar has pushed closer to parity which acts as a dampener on inflation.
One might have thought this had bought more time.
More time is important, given tonight sees the US mid-term elections and Wednesday night the infamous and potentially volatility-inspiring Fed announcement on QE2. The ECB and Bank of England make policy decisions on Thursday and the Bank of Japan has brought its policy decision forward two weeks to Friday.
The RBA had noted in the minutes of its October meeting that its “on hold” position, which had lasted since April, was to a great extent influenced by ongoing uncertainty surrounding European sovereign debt. But it couldn't wait forever, the board suggested, and the decision to stay put was “finely balanced”.
Credit spreads on risky European debt have done nothing but blow out further ever since, but it would appear the RBA is satisfied enough to believe another crisis is not around the corner.
The bulk of this month's statement was almost a carbon copy of October's, right up until the end. This month Stevens suggests that the “on hold” period from April has given the board time to “observe the effects of previous policy changes” and to “monitor the uncertain global outlook”. As noted above, the Australian economy does not appear to yet be running away and there are still some clouds over Europe. But there's always a “but”, or in this case a “however”:
“However, the economy is now subject to a large expansionary shock from the high terms of trade and has relatively modest amounts of spare capacity. Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains. At today's meeting, the Board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent.”
The RBA has thus chosen November to make its preemptive monetary policy strike against inflation pressures. Forget the September CPI, forget credit demand, forget offshore goings on. In October the RBA spoke of a “large rise in Australia's terms of trade”. Today that's a “large expansionary shock”. And that's all that matters.
The RBA is playing once bitten, twice shy, having found itself too slow to move under similar circumstances in early 2008. In that period, it was ultimately to move its cash rate one step too far.
We will never know, however, if Glenn Stevens has been on the phone to Ben Bernanke. That is not to suggest anything sinister – just sensible communication between global central bankers.
The cash rate is now 4.75%. What will the banks do? Comrade Joe is dusting off his red flag.
Read the full statement here.