Going on last week’s intense focus on the Reserve Bank’s rate cut and then the National Accounts for the June quarter, you would have expected the appearance in public by a commenting Reserve Bank Governor would have been the headline grabber. But overnight a much bigger deal: the US Government’s $US200 billion-plus bailout of the US financial system and mortgage giants, Fannie Mae and Freddie Mac.

Not only did it overshadow Governor Glenn Stevens appearance and testimony before a Federal Parliamentary Committee, the bailout overshadowed what were some more bad news on the US economy and banking. US bonds fell sharply with the price dropping so far that yields rose 0.13% this morning on the 10 year bond to around 3.83% from Friday’s nervous 3.70% (they had fallen to 3.55% on Thursday in trading amid the huge sell off in shares that day).

But currencies were more circumspect: the Aussie dollar edged a touch higher and the US dollar was a bit weaker. Our currency fell as Stevens hinted at another rate cut in testimony to the House of Representatives Economics Committee, and then rose past 83 cents again, only to ease back under as traders punted on US rates and the greenback rising on the Fannie and Freddie news.

Our market was up more than 150 points from Friday’s 101 point fall: a big turnaround in sentiment. That was despite more weakness in commodities, though oil bounced back to around $US108 a barrel with another Hurricane eying off the US southern states. Copper was very weak on Friday, but it rose this morning in Asian trading, as did gold.

Forex traders are worried about the real message from the rescue, that the US economy and financial system are distinctly unhealthy, as moribund as Europe, the UK and Japan and not better placed. That the bailout was a last resort event didn’t occur to many investors. It will when the bills start arriving.

Stevens said that it will be another six months at least before we see inflation start falling, that demand in the domestic economy will remain moderate for longer than normal to do this and that inflation will take a lot longer (a couple of years) to fall back to the target band of 2%-3%a year.

Admittedly, we are probably six months away from seeing clear evidence that inflation has begun to fall, and even then it has to fall quite some distance before it is back to rates consistent with achieving two to three per cent on average,” Mr Stevens told the Economics Committee hearing in Melbourne this morning in his introductory remarks.

It is expected that annual CPI inflation will reach a peak in the September quarter of about 5 per cent, and be similar in the December quarter. This is higher than expected six months ago. But with international oil prices below their mid-year peaks and signs that the pace of food price increases are abating, it is reasonable to expect that CPI inflation will thereafter start to fall back. With demand growth slower, capacity utilisation, while still high, is tending to decline. Trends such as this usually dampen underlying price pressures over time, and those effects should start to become apparent during 2009 and continue into 2010.

When asked if there was a risk of recession he said there was no evidence to suggest there could be a recession in Australia, although it couldn’t be ruled out completely.

Is there a zero risk of recession? No, it’s not zero but the most likely one is the one in the published outlook.

We’re in slow growth-like period … I don’t think it would be honest to deny there are some probabilities of that but the most likely outcome is the one we put out over the last six months.

He ruled out a rate rise, adding: 

I think in the near-term the question will be: Do we hold (rates) here or do we go down a bit more? Unless something quite surprising happens, it seems to be unlikely that we’ll be reversing course up again in the near term.

Stevens also went into bat for his own rate rises from February and March this year, saying they “had to be done” (If you think back … the likelihood we’d be able to sit through one bad CPI and another and not respond at well was unlikely), before pointing out that the RBA’s rate cut last week from 7.25% to 7% would not have been possible without the earlier rate rises.

Interestingly Mr Stevens said there was nothing in last week’s National Accounts for the June quarter that would force the bank to change its forecasts. “There was nothing in those figures to cause us to revise significantly the forecasts we published in the August Statement on Monetary Policy,” he told the Committee in his opening remarks.

He warned, in a sort of circumspect fashion, that unemployment is likely to rise as the economy slows, saying that the rise in the jobless rate will be similar to 2001, when the economy slowed.

I think, in many respects we could see what’s happening is akin to the mid-cycle pause in 2001. Unemployment rose a percentage point, mid-cycle to 18 months, that sort of episode is what we’re experiencing now. We observe the unemployment rates goes up for a little while, while inflation stabilises for a little while – that was the story in 2001.It’s going to rise a bit in the next year to 18 months.

Peter Fray

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