Stephen Bartholomeusz
Rating the recovery
The Reserve Bank’s Cup Day rate rise will have come as no shock to anyone, although its modest magnitude will be a relief to those who thought there was some prospect of a 50 basis point move. The 25 basis point increase chosen is consistent with the view that, while the economic recovery is still patchy, it is now solidly underway.
In fact that was the picture drawn by yesterday’s mid-year economic forecasts – one of higher-than-expected growth, lower unemployment and slightly higher inflation than had previously been anticipated by Treasury.
However, the RBA has been somewhat more optimistic, or perhaps more wary, than Treasury and made it clear last month, when it started reversing the cycle of steadily dropping rates throughout the financial crisis, that the emergency was over and it was starting the process of moving rates back to more normal settings.
It remains comfortable that the global recovery is underway and even more comfortable that the economies of Australia’s major trading partners are going to grow at close to trend in 2010.
While the impact of the stimulus injected into the domestic economy is now wearing off, economic conditions had been stronger than expected and inflation, which had been declining over the past year, was now unlikely to fall as far as earlier thought and was expected to be consistent with the RBA’s target in 2010.
Housing credit growth was solid and prices had risen appreciably but business borrowing was declining as companies sought to decrease leverage and banks tightened lending standards (and re-price credit to business).
RBA governor Glenn Stevens didn’t place any particular emphasis on house prices in the statement, but the recent surge in prices would no doubt be causing it some concern, even if the returning strength to housing appears to be related more to fundamental supply and demand issues than speculative activity.
One could look at the broader settings – minimal growth in most of the developed economies and therefore minimal levels of global inflation, a much stronger Australian dollar to, as the governor said, dampen price pressures and economic growth of 1.5 per cent now forecast for this financial year – and be bemused that the RBA feels obliged to push rates up.
Apart from the significant lag between the announcement of a rate rise and its effect on the economy, at 3.5 per cent the official rate is still in a stimulatory position and a 25 basis point increase or two shouldn’t have any material impact on confidence or activity.
The RBA is obviously not particularly concerned at this point about a too-rapid recovery or it would have rolled out the shock tactic of a 50 basis point rise to get everyone’s attention.
It is aware – it noted – that the banks are still pushing through increases in risk margins to their business customers, large and small, and therefore there is a quite broad and substantial rise in the cost of borrowings occurring quite independent of official monetary policy.
There is also some rationing of business credit for customers of at least some of the major banks as part of a shift of their focus to the less risky and less capital-intensive home loan sector. With the small banks funding-constrained and some lessening of foreign bank activity, the market is probably more of a dampener on activity than the RBA.
The other aspect of the RBA’s rate rises is that, at this stage at least, leading the world in removing their stimulus isn’t a particularly risky strategy.
The major threat to the Australian economy still lies offshore, within the global financial system and its interaction with the more stressed real economies in Europe and the US.
If there is a fresh shock, which is quite conceivable given the continuing fragility of the system and the sheer weakness and debt-constrained state of some of the major economies, both the RBA and the Rudd government have significantly more capacity to respond again than any of their peers.
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