Tuesday, January 22, 2008

What's the Reserve Bank likely to do? Sit on its hands.

Looking for a silver lining? There is one. Even if today’s inflation news is awful (and it almost certainly will be) the Reserve Bank is unlikely to push up interest rates.

In normal circumstances if the inflation number due out this morning was bad the Reserve Bank board would push up interest rates almost automatically.

Not even an election would stop it, as we discovered late last year...

The Bank’s trigger for a rate hike is 0.8 per cent. If the quarterly rate of underlying inflation comes in at 0.8 per cent or higher, the Bank takes it as a sign that the annual rate of inflation will soon be above 3 per cent and jacks up rates.

If the quarterly rate is 0.7 per cent or below, it leaves rates put.

But not this time.

Westpac and the ANZ are predicting a shocker of an inflation result today – an underlying inflation rate of 0.9 per cent for the quarter and 3.4 per cent for the year – well above the Reserve Bank’s 3 per cent ceiling for the first time.

But the Bank’s board won’t react as it usually would when it meets on February 5.

For two reasons.

One is that this month Australia’s big private banks put up their rates independently of the Reserve, doing some of its work for it. It might want to wait and see what happens.

The other is that the share market rout changes everything.

In an immediate sense it is making well-off Australians poorer, especially those in deep pain who have borrowed to buy shares. That itself by itself will take pressure of inflation as they find themselves less able to spray around money.

The other is that the rout could bring on a worldwide economic slowdown. Goldman Sachs yesterday downgraded its forecast for Australian growth this year from 3.5 per cent to 3 per cent. It cut its forecast for next year to 2.75 per cent.

Malcolm Turnbull used to run Goldman Sachs in Australia. He is now the Opposition’s Treasury spokesman. He thinks that the rout is already hurting the economy.

As he put it yesterday: “As every day goes by, the case for the Reserve Bank holding its hand and not raising rates becomes stronger”.

The Bank is likely to agree with him and sit on those hands when it next meets, no matter how bad our rate of inflation.

Panic selling wiped almost $100 billion off the value of Australian shares yesterday as Australian market suffered its biggest one-day loss in two decades, erasing all of the gains made over the last year.

The 7.26 per cent collapse in the All Ordinaries index followed a collapse of 5.48 per cent in London, it’s biggest since the September 11 2001 terrorist attacks, and falls of 6.83 per cent in Paris and 7.16 per cent in Frankfurt. It was paced by falls of 5.65 per cent in Tokyo and 8.7 per cent in Hong Kong.

The Australian market is down 23 per cent from its peak in November, a loss of $388 billion. It has lost all of its gains since October 2006.

The website of Australia’s biggest on-line broker Commsec crashed for 20 minutes after the start of trade yesterday as an unprecedented number of customers attempted to get on line sell stocks.

Commsec and other brokers were also busy demanding margin calls from customers who had borrowed to buy stocks and no longer had the security to justify their loans. The broker said it was using mobile phone messages to alert customers of the need to put in more cash.

It was the 12th straight day of losses on the Australian share market – its longest losing streak since 1982.

The ASX200 index slid 393.6 points to 5186.8; a collapse of 7.05 per cent. The All Ordinaries index fell 408.9 points to 5,222; its biggest one day loss since October 1987 and fourth-biggest on record.

$96 billion was wiped off the value of the All Ordinaries index, taking the loss since the start of the year to $282 billion.

Among the big losers were the ANZ bank which fell 7.06 per cent to $24.35, the National Australia Bank, which fell 6.53 per cent to $32.90, BHP Billiton which fell $2.29 to $31.00 and its takeover target Rio Tinto which slid 11.6 per cent, to $101.00.

James Packer's Consolidated Media Holdings was one of the very few stocks to increase in value, closing 9.59 per cent higher, up 37 cents after news of a $3.31 billion joint-venture takeover offer from for the company from Lachlan Murdoch in co-operation with Mr Packer.

The Treasurer Wayne Swan expressed confidence in the Australian market swaying he believed it was “well placed to ride out the turbulence that flows from events in the United States even though we are not immune from it”.

However on the Futures Exchange, the March share price index contract slid a further 340 points, or 6.08 per cent, to 5,256 indicating that traders believe there are more losses ahead.

The US billionaire investor George Soros was quoted as saying that the world was facing the worst financial crisis since World War II and that the US was threatened with recession.

In an interview with an Austrian newspaper he said that the belief that financial market tended to balance was wrong and that the financial crisis was serious.

In Australia the chief equities economist at Commsec Craig James said the fundamentals for the Australian economy have not changed. “Unemployment is near 33-year lows, the economy is growing at a firm clip of above 4 per cent and the budget is in surplus,” he said.

Plenty of value had been unearthed on the Australian share market and investors would be “chafing at the bit to pick up the bargains”. But it was too early to say when. “The slide may have further to go.”