The Reserve Bank’s move to a rate cutting stance from early this month, despite our continuing high inflation rate, can be clearly seen from the minutes of the 5 August board meeting, released this morning.

The change in the bank’s attitude to rate cuts was first noted in the statement after the meeting by Governor Glenn Stevens and then in two speeches last week by Assistant Governor, Phil Lowe and Deputy Governor, Ric Battellino.

While our present high inflation rate got the usual mention in the minutes, as did the injection of money from higher iron ore, oil and coal prices, the slowing domestic economy and the much sharper tightening in financial conditions seems to have won the day.

In fact it seems to have been fears that monetary policy had been further tightened by the extra rate increases levied by the banks from the credit crunch impact (and the unspoken impact of sharply higher petrol prices) that seems to have forced the RBA’s hand. The extra 0.55% imposed by the banks on top of the 1% in rate rises from the RBA since last August played a big part in producing the switch to a rate cutting stance.

There was little mention of the impact of the surge in oil and petrol prices, but they obviously had a big impact, as we have seen from some retailers’ sales figures, magazine circulation figures, especially for the June half year and several other indicators on consumer spending and consumer confidence.

The comments by the bank (in bold below) would also explain why the RBA has been so forthright in bashing the banks over passing on rate cuts to consumers. The RBA has become fearful that monetary policy may be excessively tight!

After pointing out that the current high inflation rate, plus even higher readings later in the year “argued for maintaining the current stance of policy,” the board went on to canvass what was actually happening in the economy.

And, compared to what it said after the previous board meeting (that is: “On balance, while members remained concerned about the current rate of inflation and the uncertainties about the outlook, the increasing signs that demand was slowing suggested that the existing policy setting was exerting the appropriate degree of restraint. Provided demand continued to evolve as expected, inflation was likely to decline over time.”) the change was enormous.

Members were conscious that financial conditions were clearly quite tight, and effectively getting tighter as a result of ongoing pressure on lenders’ cost of funds in the market.

Given there had been a significant change in borrowing behaviour, confidence was weaker, asset prices had declined and slower overall growth was in prospect, tighter financial conditions were not warranted. Indeed, less restrictive conditions could soon be called for, otherwise the risk of a deeper and more persistent slowing in the economy would increase. (That’s the key phrase in the minutes).

On these considerations, a case could be made for an early reduction in the cash rate.

Weighing up all these considerations, members judged that the current stance of policy was appropriate for the time being.

Nonetheless, given the slower trend in demand, scope to move towards a less restrictive setting of monetary policy was judged to be increasing.”

And early next month the bank will cut rates by at least 0.25% and then back up later in the year.

Peter Fray

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