Another Reserve Bank board meeting yesterday and another month in which official rates have been left unchanged. The next rate rise, however, now definitely appears to be on the RBA’s horizon.
There are two things that appear to have staved off an increase so far this year. One is the fragile state of consumers’ confidence, reflected in their lower spending and greater saving, and the other is the soaring dollar, which is having its own disciplining impact on activity and inflation.
The extraordinary terms of trade, the accelerating boom in investment, mainly in the resource sector, low unemployment, growth in wages and the surge in utility prices, however, continue to provide the foundations for the argument that rates will have to start rising again.
While Glenn Stevens noted that the natural disasters over the summer had reduced output in some sectors and that it was taking longer than expected for coal production to resume from flooded Queensland mines, and this was likely to cause a decline in real GDP in the March quarter, he also said that overall growth in the medium term was likely to be at trend or higher.
As the temporary price shocks from the floods and cyclone dissipated, CPI inflation would be close to target over the year ahead but “looking through these short-term movements” recent information suggested that the marked decline in underlying inflation from its peak in 2008 “has now run its course”.
The exchange rate would help hold down prices for some consumer products over the next few quarters, but over the longer-term inflation could be expected to increase “somewhat” if economic conditions evolved broadly as expected, Stevens said.
Given that the RBA sees monetary policy as a tool to be used pre-emptively, that suggests the next rate rise — the first since the contentious 25 basis point increase last November that appears to have punctured consumer confidence — is not too far away.
Wayne Swan, in framing what he says will be a tough budget, is presumably conscious that anything less than that would be likely to force the RBA’s hand, with unpleasant political consequences.
The question of the next rate rise is a delicate one.
The labour market is tightening, wages are starting to grow after being under pressure during the financial crisis, and there is an absolute and unprecedented avalanche of investment pouring at a rapidly rising rate into the resource sector.
Most households, however, have developed severe risk-aversion and their conservatism is rippling through the retail sector and showing up in house prices, which are starting to slide. If that were to continue — and the next rate rise could easily trigger a bigger rate of decline — a nasty feedback loop between consumer confidence and asset values might develop.
That’s the problem with trying to manage an economy operating in two very different dimensions — what might be appropriate for one could cause destruction in the other. Wayne Swan might believe Stevens and his team are paid too much, but an awkward moment is looming where they will well and truly have the opportunity to demonstrate their value to the economy.
*This first appeared on Business Spectator.