Tuesday, August 14, 2007

Danger! Danger! Rate rises ahead!

The Reserve Bank has begun preparing the ground for yet another hike in interest rates – one that would take Australia’s standard variable mortgage rate to 8.55 per cent.

Less than a week after its last hike, which will take the rate to 8.3 per cent, the Bank used its Quarterly Statement released yesterday to lift its inflation forecast to the very top of its target band.

The Bank said that even after last week’s interest rate hike it expected Australia’s underlying inflation rate to climb to 3 per cent by December, the limit of what it can tolerate.

It expected the rate to stay that high through much of 2008 and warned of pressures that could push it higher still.

It said Australia’s labour market is “as tight as it has been for a generation”, borrowing by business was climbing at an annualised rate of 22 per cent, and property prices were growing firmly in every city other than Perth...

In a signal that the Bank fears its 3 per cent inflation forecast is conservative it said these factors “could result in more upward pressure on wages and inflation than has been incorporated into the forecasts”.

It said the main downside risk to its inflation forecast was a further slowdown in the United States economy leading to a downturn in worldwide inflation, something it did not think was likely.

The Bank’s comments set the scene for its Governor’s second appearance before the House of Representatives Economics Committee on Friday.

Under questioning his first appearance in February Glenn Stevens declared that he was not afraid to increase rates in an election year, replying that “if in August it needs to be done it will be done”.

Last week’s August rate hike is likely to be followed by another as soon as November, after the release of the next inflation figures due on October 24.

TD Securities told its worldwide clients last night that it would not be surprised if the Bank decided to put up rates sooner, possibly at its next board meeting in three week’s time before the election campaign got under way.

The ANZ bank, previously a sceptic about the possibility of an interest rate hike this year, told its clients that there was now “a delicious possibility that another rate increase could be in prospect in November”.

It said in “in any year other than an election year the chance would be high. Even as it is, that possibility cannot be ruled out”.

Westpac said the Bank’s Sstatement was not that “of a central bank that expects that the current tightening cycle has come to an end”. It said the Bank had indicated it would have “little patience with any evidence that inflation pressures remain strong”.

The Treasurer Peter Costello reacted to the statement by attempting to redefine the publicly understood role of the Reserve Bank.

He said the Bank had not been charged with always keeping Australia’s underlying inflation rate between 2 and 3 per cent as commonly understood, but with keeping it there “on average over the economic cycle”.

“The cycle is at its high point now. You would expect at times of weakness it will be below, at times of strength it will be above, and that the target is average,” the Treasurer said.

The Reserve Bank gave short shrift to that argument in its statement adjusting rates last week, saying that even with the underlying rate below 3 per cent it needed to increase rates to ensure inflation did not climb above the 2 to 3 per cent band.


COMMENT

The Prime Minister has blamed his advertising agency for his party’s stupid but electorally useful promise last election to keep interest rates low.

He says the advertisement was pulled after one week and that he never made that much-ridiculed promise.

But he did make this one. Last week in his radio address he singled out state government plans to run up $70 billion in debt as being “bad news for interest rates”.

He wasn’t putting pressure on rates. He was running a surplus.

Yesterday in a few short sentences in its quarterly review the Reserve Bank demolished that argument.

The Commonwealth was indeed running a surplus, but it was “expected to be a little lower in 2007/08 reflecting policy announcements”.

Things were looser for the states too. They were “projected to show a slightly larger deficit in 2007/08, due to increased infrastructure spending and slower growth in revenues.”

It was the direction of change that mattered, and both were arguably moving in the wrong direction, if only “a little” and “slightly”.

And the amount of money involved? Half of one per cent of GDP.

It’s not much. Earlier this year the Finance Minister Senator Nick Minchin pleaded to a Senate estimates hearing for understanding. A government program hadn’t been put to Cabinet, but it was just “less than half a per cent of Commonwealth government expenditure, let’s keep it in perspective”.

During the last election the Coalition verballed the Reserve Bank on interest rates, using its name to falsely imply that it supported the Coalition’s claims.

The then Governor Ian Macfarlane said later “we were sort of disappointed, but there was no way I could speak out”.

His successor looks like being less timid.