Thursday, July 24, 2008

Relax. Governor Stevens does not want to tighten rates

Here's why:

Only a year ago Australia’s inflation rate was 2 per cent - at the bottom of the Reserve Bank’s target band.

The relentless march of petrol prices, food prices, mortgages and rents has now pushed it up to 4.5 per cent and may push it even higher.

So should we be worried?

Probably not, in the view of the Reserve Bank and its Governor Glenn Stevens.

They are focused instead on thier own measures of the so-called underlying inflation rate that either discard or downplay the really big price movements in both directions.

Right now those are the increase in fuel prices – up 8.7 per cent in the quarter, and the slide in fruit prices – down 7.4 per cent.

Ignoring those in attempt to understand the more general forces at work, the Bank has concluded that Australia’s underlying quarterly price pressure is probably 1.1 per cent...

...well above the 0.6 per cent it would like, but importantly down on what it was in the previous quarter.

Believe it or not, that means the Bank is pretty pleased with itself right now. Its two interest rate hikes last year and its two this year (plus the extra hikes imposed by the banks) appear to restraining our spending and restraining price pressure.

If that continues, inflation should fall back to where the Reserve Bank wants it – not quickly, but eventually.

The Reserve Bank isn’t in a hurry.

So long as the underlying rate keeps falling, or keeps looking as if it will fall, it would be unfazed if it took until the end of 2010 for the underlying rate of inflation to get back to 0.6 per cent.

It won’t be pushing up interest rates in order to hurry it along.

Mortgagees, and Kevin Rudd and Wayne Swan can rest easy.

The Bank might even be prepared to cut rates if needed without waiting for inflation to finish falling back to within its target band and without waiting for serious evidence that the economy is in trouble.

The Reserve Bank looks ahead when it makes its decisions.

If it can see that Australia’s economy is about to turn down (as has the ACT’s) or if it can see that unemployment is about to climb, it will cut rates ahead of time.

It is tasked with avoiding a recession as well as controlling inflation. It takes both responsibilities seriously.