Tuesday, February 19, 2008

Going up. The RBA nearly did it twice

Australia’s most recent interest rate hike of 0.25 per cent was nearly double that.

The minutes of the Bank’s February board meeting reveal that it actively considered pushing up rates by 0.5 per cent in one hit this month - something it hadn’t attempted for eight years.

The news late yesterday pushed up money market expectations of a further rate hike when the board next meets in a fortnight to almost 100 per cent, with some economists predicting that that hike will be 0.5 per cent.

A 0.5 per cent hike would take the standard variable mortgage rate to 9.5 per cent, its highest level in twelve years.

It would add a further $138 to the monthly cost of servicing a $400,000 mortgage - an increase of $400 in the space of a year...

The minutes reveal extreme concern among board members about inflation, forecast in papers prepared for the meeting to remain beyond the Bank’s target band for the rest of this decade.

The forecasts - more severe than those subsequently published by the Bank - were prepared on the assumption that it left rates unchanged.

They had Australia’s underlying rate of inflation climbing to 3.75 per cent in the early months of this year and not returning to 3 per cent until mid 2010.

The headline rate of inflation - the one used for indexing government benefits and the one preferred as a measure of inflation by the Coalition during its last months in office – would climb to 4 per cent within months.

The minutes reveal that the board’s members were concerned that even that forecasts might prove to be optimistic.

Among those present at the meeting were the former head of Woolworths Roger Corbett, the Chairman of Telstra Donald McGauchie, the ANU’s Warwick McKibbin and a senior Treasury official David Gruen standing in for the Treasury Secretary Ken Henry.

The members noted that a “good case” could be made for an 0.5 per cent hike in February order to send a sharp signal that the board would do whatever was necessary to regain control of prices.

Some members argued that, adjusted for inflation, professional interest rates were arguably “noticeably below what might be expected” given Australia’s economic circumstances.

In the event the board decided to lift rates by only 0.25 per cent in February in the knowledge that the private banks themselves had boosted rates the previous month independently of the Reserve.

It noted that “additional tightening could be implemented at the March and/or subsequent meetings as judged necessary”.

The decision to lift rates by 0.25 per cent rather 0.5 per cent was said to be “finely balanced”.

The board’s thinking next month will turn on labour price figures due to be released by the Bureau of Statistics this morning.

The board will also take into account news of what appears to be a 65 per cent increase in the price of iron ore negotiated by one of the world’s biggest miners which appears set to boost Australia’s export income by a further $30 billion, pushing Australia’s terms of trade to a new all-time high.

The Bank’s Assistant Governor Malcolm Edey noted at a conference in Sydney yesterday that for the last four years Australia’s terms of trade had climbed by 8 per cent per annum – the largest cumulative run-up since the 1950s.

In Parliament yesterday the Opposition’s Treasury Spokesman Malcolm Turnbull claimed that in the face of the resources boom further hikes in interest rate hikes would be unlikely to dent inflation in the resource-rich states of Queensland and Western Australia.