The rate rise clearly will not
induce bananas to grow faster, or oil sheiks to produce more oil. But it will
help to ensure that the rise in the relative price of bananas and oil is more
closely offset by lesser rises, or even falls, in less-supply-constrained goods
and services. So in the fullness of time, assuming some further rate increases
that the RBA Board may have envisaged but have not yet determined are definite,
the rate of underlying inflation should rise less rapidly or even
fall.

The move makes the private sector
wear the pain and leaves the government sector untouched (snouts still in the
trough). At the margin, this 25bp rate rise will squeeze private sector demand
(but leave government demand unchanged), lead to postponement of private sector
housing construction and purchases, lead more to seek jobs and induce private
business (but not government) to lay off a few more workers, reduce consumer
confidence, lower the appetite for debt (but increase the supply of debt), lower
the net present value of future earnings and so reduce the value of most
equities (especially those most leveraged to the economic cycle, like banks) and
– also at the margin – knock out some private sector investment projects. It
will also keep the A$ stronger than otherwise and make exporting less profitable
and importing more profitable.

As the 25bp increase was well
expected, the impact on forward-looking markets (such as equities) will be quite
limited. Only the economically illiterate will have been surprised and will not
have already adjusted their spending and saving
plans.

But the more important point is
that, at 6.0%, the cash rate is still at a level that the RBA has found to be
“neutral”, rather than restrictive. Glenn Stevens, now the King, said in
February 2004 that the cash rate had to be 6.25% or higher to be restrictive. In
practical terms, that means that the impact on aggregate demand and thus on
slowing inflation will be very limited. The RBA admits as much in its brief
explanatory statement, which notes how attractive finance has been to borrowers
at recent interest rates. I do not sense that 6.0% is the tipping
point.

Despite the RBA’s sophistry in
claiming that the underlying rate of inflation is “just below 3%” (as if
the difference is worth noting!) it is gratifying to see that at least
the RBA is not slipping any further behind in its battle to contain the acceleration in
inflationary expectations. The pity is that the rate rise would have been
unnecessary if the government had taken a knife to its bloated consumption
budget.

Peter Fray

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