If I was to tell you readers that the Reserve Bank had suggested that we could get further rate cuts if inflation continues to fall in coming months, you’d be entitled to pack me off to a sanatorium for a bit of rest and re-orientation.

After all, I am writing about high inflation Australia, where prices seem to only know how to rise, (unlike, Europe, and the US at the moment, where prices are either easing or flat), and inflation complaining has become part of the national whine.

But I have to assure you that’s the very strong suggestion left from today’s statement by Reserve Bank Governor, Glenn Stevens that saw the cash rate left steady at 3%, a 49 year low.

In an attempt to make clear that it still has a bias to ease rates further, if need be, the RBA linked the possible cuts to a further decline in inflation in coming months.

Monetary policy has been eased significantly.

Market and mortgage rates are at very low levels by historical standards. Business loan rates are below average.

Much of the effect of this is yet to be observed. Fiscal measures are also providing considerable support for demand.

Nonetheless, the prospect of inflation declining over the medium term suggests that scope remains for some further easing of monetary policy, if needed. In assessing how it might use that scope.

That sentence was nowhere to be seen in the statements after the May or any other meetings.

It’s rate, extremely rare see the Australian central bank link further monetary policy easings (AKA rate cuts) to declines in inflation.

And, how will inflation ease?

By the continued rise in the value of the Australian dollar, which was over 81 cents in trading today, a nine month high. In fact, the dollar is up 33% since its lows and rose 6% in trade weighted terms last month (which was nearly half the 14% rise for 2009 so far).

It’s hurting export returns, tourism and others, but it is softening the impact of the rising price of oil at the petrol pump.

In the statement after the May 5 meeting, Governor Stevens said this about inflation:

With demand for labour weakening, growth in labour costs will probably also fall. These conditions are likely to see inflation continue to abate, though this is occurring only gradually so far, as the effects of the decline in the exchange rate are pushing up some prices.

No mention after the May meeting of “the prospect of inflation declining over the medium term”.

In fact so long as this rebound in markets continues without any significant or dislocating correction, we can expect to see interest rates at this current very low level for sometime to come, if not lower if the Aussie dollar takes another spurt upwards.

So far no fears whatsoever about the size of the Federal Government deficit or its borrowing campaign in coming years. In financial markets it’s a non-story, despite the best efforts of the federal Opposition to make it one.

Peter Fray

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