On the face of it, the Reserve Bank board has given itself enough wriggle room to lift interest rates next month, the month after or in December, and it has also given itself enough wriggle room not to increase them.

But seeing a fortnight is a long time in economics these days, and monetary policy, when the euro is wobbling and Europe’s salvation seems to be doubted by investors around the world, the bank could even muster a case for a rate cut if there was a crash in Europe.

The minutes of the May 4 RBA board meeting  were a long time ago, in a slightly different environment than now where fear of risk and gloom has captured market sentiment, despite the attempts by Europe to protect itself with that huge support mechanism announced at the start of last week.

The board meeting was held in the week ending May 8. On May 10 the eurozone, EU, European Central Bank and the IMF unveiled the mega €750 billion support mechanism for the weaker countries such as Greece, Spain, Italy and Portugal, and for the currency itself.

That saw a surge in markets, for a day, and then a steady draining away of that confidence, culminating in a miserable day on Asian and Australian markets yesterday, and a slightly better one in the US overnight, and Asia today.

But if the meeting was to be held today, there’d be no rate rise; those changed conditions in global markets have impacted confidence in markets here to the point where a rate rise today would have been counterproductive.

The erosion of confidence in Europe, the euro and a rise in fears about a renewed slide into recession later this year, no matter how pessimistic they might seem, will be enough to keep the RBA hand off the rate lever for a while.

The problems in Greece and Europe were extensively discussed at the meeting on May 4.

“Members spent considerable time discussing the disturbances in financial markets arising from concerns about sovereign debt in parts of Europe, with their focus particularly, but not only, on Greece.

“The measures of financial support for Greece so far announced had not managed to calm markets. There was a risk that the situation could worsen further, damaging the global economic recovery.

“However, while there had been some decline in global equity prices and some impact on exchange rates, so far at least there had not been significant contagion to debt markets outside Europe; the direct impact of Greece on Australia was considered to be small.”

Since then the impact on Australia has grown, Monday’s slump in the market was a shock to a lot of people. It pushed the Australian market down by 10%-11% by the end of the day from the peak in mid-April. That’s correction territory.

Today’s market recovery has been half-hearted at best. Fear of risk (the Australian dollar dropped a cent overnight as the euro hit a four-year low against the US currency) is back and dominating sentiment.

So while the RBA minutes described monetary policy as being “well placed for the present”, which would indicate a pause, they also indicate there was some lengthy discussion of whether a rate rise would be right.

“Nonetheless, the stimulatory effects of the resources boom would be building over the year ahead. Members were conscious of the need for this not to result in a material worsening in the medium-term outlook for inflation.

“This was weighed against the case that could be made for a pause in the process of normalising interest rates owing to the uncertainty in the euro area.

“On balance, members judged it to be prudent to undertake some further monetary tightening at this meeting. They noted that, if lenders responded as expected to another rise in the cash rate, interest rates faced by most borrowers would then be at around their average levels over the past decade.

“Members felt that this would leave monetary policy well placed for the present. The board therefore supported another rise in the cash rate.”

The most interesting phrase is that last paragraph: “The board therefore supported another rise in the cash rate”. It was been absent from statements in April and March this year when rate rises were agreed to.

Could it be that agreement had been reached after lengthy discussion on whether one was needed given the rising level of unease over Europe?

Peter Fray

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