By invitation, I wrote the following Op-Ed article for publication in one of the dailies tomorrow morning. I had 500 words so couldn’t say much. The good thing about today is how wrong the market economists were. The bookies even closed the book because they claimed it was a 100 per cent probability that the RBA would put up rates. Anyway, they didn’t which is good but they will which is bad.
Contrary to the expectations of the financial markets, the Reserve Bank of Australia (RBA) held its policy interest rate constant today at 3.75 per cent. This was always a likely option given the fragile state of the economy and the need to foster private investment spending.
The financial markets were wrong again. Given that the recent financial crisis was engendered by the poor judgement of market participants, one wonders why they still have the credibility that the media ascribes to them.
After noting that the recovery in the major economies is likely to be modest over the next two years, the RBA statement said that “inflation is expected to be consistent with the target in 2010”.
Monetary policy is conducted principally by the RBA manipulating the short-term interest rate upon which all other rates (mortgages, etc) are based. Its aims to keep inflation within a 2 to 3 per cent band by moderating aggregate spending.
The RBA increased rates three times in late 2009 which moved its target rate towards its so-called neutral range – where policy is neither expansionary nor contractionary – somewhere between 5 and 6 per cent.
That assessment is not uncontroversial and I have criticised the RBA for keeping rates too high prior to the crisis given the record debt levels being carried by households.
Today’s decision reflects the fact that the major banks pushed their lending rates up proportionately more than the official rise in late 2009. This has led the RBA to reconsider its assessment of its neutral policy range.
In December, the RBA indicated that its neutral rate was probably much lower than previously thought and at 3.75 per cent was likely to be in the neutral range (albeit at the expansionary end).
Today they noted that the impacts of these excessive commercial bank rate increases were still unclear and so it was “appropriate to hold a steady setting of monetary policy for the time being”.
I consider the decision to be sound. With economic growth still subdued and labour underutilisation rates high there is plenty of excess productive capacity and thus no danger of an inflation breakout in the foreseeable future.
The last thing we need is for monetary and fiscal policy to be working against each other which might jeopardise the modest recovery we are now witnessing. The fiscal policy stimulus is waning now and so continued growth will be reliant on strengthening private investment.
Recent data covering job advertisements and business confidence is still pointing to a very fragile economy.
What about the future? The RBA signalled that if growth continues as expected then monetary policy “will, over time, need to be adjusted further in order to ensure that inflation remains consistent with the target over the medium term”.
But with the excessive commercial bank rate hikes, I don’t foresee a return to 5 or 6 per cent interest rate this year. Some modest rises in the coming months will be likely though.