Reserve Bank Governor Glenn Stevens chose the House of Representatives standing committee on the economy to deliver a few calming words about inflation, the markets and interest rates in Sydney today.

And as he was wrapping up his appearance the Australian Bureau of Statistics delivered the day’s big economic news, a 0.1% fall in seasonally adjusted retail sales in February, a statistic that adds to the RBA’s belief that demand pressures are moderating. But like all statistics, the figures were not clear cut with the fall in February not being uniform: a big 1.6% fall in Victoria and a 0.6% drop in booming WA more than offset rises in all other states and territories.

Stevens’ comments to the committee were aimed at Shadow Treasurer Malcolm Turnbull, who has been getting into the banks about interest rates, growth and inflation. Turnbull has claimed that the economy is “two speed“, if not diverging, with faster growth states like Western Australia and Queensland causing the demand problems that have led to higher inflation and interest rates penalising the sluggish states like New South Wales and Victoria.

Stevens replied to Turnbull’s claims by saying that, “While there continue to be differences in the degree of overall strength of the economy by region, those differences, if anything, narrowed during 2007. Unemployment rates in the big south‑eastern states, for example, were at generational lows on the most recent reading.”

Stevens also rebutted Turnbull’s recent criticism of the RBA’s handling of inflation and its impact on demand and the difficulties of relying on headline CPI numbers.

Stevens said in his opening remarks:

The pace of demand growth in 2007 well and truly exceeded any plausible estimate of the rate of growth of the economy’s supply potential. Under these demand conditions, inflation increased. Having apparently moderated a little late in 2006 and early 2007, it began to show higher readings around the middle of 2007 and by the end of the year had reached about 3½ per cent in underlying terms. Measured by the CPI, the year‑ended inflation rate was 3 per cent, but as is well understood, the next figure is likely to be around 4 per cent.

Faced with this combination – very strong demand growth in what was already a pretty fully employed economy, and inflation moving higher – the Reserve Bank Board, when discharging its monetary policy duties, could draw no other conclusion than that growth in demand needed to slow.

Stevens also directed his speech to economists and other nervous nellies in the market, who are inclined to predict a “looming interest rate rise” every time seemingly poor statistics are released:

We do think, however, that demand growth in Australia is now in the process of moderating. The demand for credit by households has also been weakening over recent months. Measures of confidence have declined. While those measures can provide false signals, our assessment is that a change in trend is occurring, and we are hearing that from businesses we talk to. A tightening in financial conditions, lower share prices and heightened concerns over the global financial problems will all have played a part in this change.

There is at least some evidence that a moderation in demand is occurring. That, if it continues, should in due course act to slow prices.

This will by no means be an easy balance to strike. But if, by restraining demand for a while, we can secure a gradual reduction in inflation over the period ahead, then an important foundation of Australia’s good macroeconomic performance over the past decade and a half will remain in place. That, in turn, will offer the prospect of good sustainable growth into the next decade. That is the goal of monetary policy.

Stevens’  comments are, like those in this week’s statement after the board meeting, far more moderate than we read in Fevbruary when the bank turned bearish and decided to get out the big stick.

It means rates are on hold: although if the stockmarket continues rising, the bank will start fretting again. It doesn’t want to see animal spirits set free, not yet. It wants them bottled up for another year, or rates will be increased.

Only time will tell whether the RBA Governor’s words have a calming effect on the Shadow Treasurer, economic commentators and the market.

Peter Fray

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