Good and evil in interest rates

According to Peter Martin:

The Reserve Bank believes inflation has bottomed and it will soon have to lift interest rates, possibly even next month.

The bank’s change of heart emerged during a three-hour board meeting yesterday that resolved to leave the cash rate steady at 4.75per cent but to be prepared to lift it without waiting for the next quarterly inflation figure.

The consensus of the meeting was that last week’s unexpectedly high inflation figure showed the underlying rate had dropped to 2.25 per cent and was set to climb.

According to the perpetually inflationary Adam Carr:

June is live, for sure it is – the bank pretty much makes this point in the last sentence where it states that “in future meetings, the Board will continue to assess carefully, the evolving outlook for growth and inflation”. There is certainly no promise of a hike at that meeting in this statement, but as mentioned I think the RBA will hike and I think their language today simply reflects the fact they are still coming to terms with current data rather than any genuine analytical stance. On any sensible read, the case is clear cut, a lay down misere as it were. But having misread things, they need time to adapt.

According to Terry McCrann:

So the prediction of a rate rise out of the next meeting is predicated on the assumption that we don’t get a shock left-field disaster, and that “events” broadly develop as now seem likely.

What we got out of yesterday’s meeting was a statement by RBA Governor Glenn Stevens in two parts and carefully shaded.

There was a tendency by market commentators to misread the first part and not to see the shading – leading to their conclusion that it all marked only a slight shift in the RBA’s policy stance from previously, and so that it was still ‘pointing’ to the first likely rate rise towards the end of the year.

Even rate hawks like former R Banker Paul Bloxham suggested the first rise would be in July-August, and more likely the later month, while CommSec’s Craig James black-inked: “In short, there is no justification to lift rates, and no inclination to lift rates in the near future.”

They could, of course, prove to be right. But – that “water” issue aside – I doubt it.

Even though McCrann sees the “shaded” areas of the statement he still misreads them. Here’s what the RBA said:

Growth in employment has moderated over recent months and the unemployment rate has been little changed, near 5 per cent. Most leading indicators suggest further growth in employment, though most likely at a slower pace than in 2010. Reports of skills shortages remain confined, at this point, to the resources and related sectors. After the significant decline in 2009, growth in wages has returned to rates seen prior to the downturn.

Overall credit growth remains quite modest. Signs have continued to emerge of some greater willingness to lend, and business credit has resumed growth after a period of contraction. Growth in credit to households, on the other hand, has softened recently, as have housing prices in several cities. The exchange rate has risen further and, in real effective terms, is at its highest level in several decades. This, if sustained, could be expected to exert additional restraint on the traded sector.

Recent data on inflation show the effects of production losses due to the floods and Cyclone Yasi. The affected prices should fall back later in the year, though substantial rises in utilities prices are still occurring. The Bank expects that, as the temporary price shocks dissipate over the coming quarters, CPI inflation will be close to target over the year ahead.

Looking through these short-term movements, however, the recent information suggests that the marked decline in underlying inflation from the peak in 2008 has now run its course. While the rising exchange rate will be helping to hold down prices for some consumer products over the coming few quarters, over the longer term inflation can be expected to increase somewhat if economic conditions evolve broadly as expected.

As usual, commentators are far too black and white. It reminds me of an explanation for why the neoconservatives of the Bush Administration were so naive about good, evil and liberating Iraq. It wasn’t because they were influenced by Israel or after oil (well, perhaps that one) it was because they were all ex-journalists. That is, they see the world as either TERRIBLE or WONDERFUL and nothing in between.

Read what the RBA has written, not what the hysterics tell you. Employment growth will slow, housing and credit have weakened, the tradable sector is increasingly constrained. As the flood effects recede inflation will be near target. And yes, inflation has bottomed and commodities are strong. The balance of this is the same as it has been, a bias to tighten with “the Board continu[ing] to assess carefully the evolving outlook for growth and inflation.” But the formulation is slightly different. That is, the pressure to raise rates is growing but so are the risks of doing so, and you, like them, need to watch the data closely.

Of all the prognosticators, only Bartho gets it right:

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.


  1. Maybe H&H
    “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.”

    I’d have thought that it’s really more a problem of trying to manage an economy with far too much debt.

  2. Deus Forex Machina

    Nicely done H&H…that’s the best piecce on that topic I’ve read this morning…by the length of the Flemington Straight.

  3. One thing I’m learning about all this, is paid economists really have no idea what they are talking about. They are paid to “Talk their own book” and everything they say should be taken with a grain of salt.

    I still stand by my forecast done in Dec10, the next move will be down. Talking to real people in business how the Nov10 rise has totally kicked them in the head, there isnt any other direction. Its the straw that broke the camels back.

    Over consumption is the only reason to raise rates. Since Nov10, this has fallen off a cliff. Inflation is at the top end BUT there isnt any inflation being caused by consumption. Its all being caused by external factors and by Govt spending. (I include utility prices in here) (Neither will drop the official inflation figures by the RBA increasing the OCR)

    The Aussie population know the current situation isnt good, but we are all being fed the lines from the Govt and the RBA about this massive wave of $$$ coming to fill everybodies pockets with $100 notes.

    The wave may be coming BUT as we have seen over the last 24 hours with silver dropping about 20%, it could drop before hitting our shores. Add what May and June has in for us with the US debt situation, will stop the wave in its tracks.

    (On a side note with Govt spending on utilities pushing up prices (Besides DeSal plants (Past Vic Govt spending $5 Bil and over 25 years will cost $25B), take a drive around NW Sydney past Dural. U will see Country Energy have replaced most of the power poles and wires W to Windsor, N up to Perrys Crossing. Speaking to people in this area, they never had problems with power, but C.E (aka NSW Govt)have decided to replace everything)= higher power prices for nothing.

  4. Rob
    “Over consumption is the only reason to raise rates.”
    We’re way over-consuming – just not quite as much as we were before.

    For practical purposes as to the next move by the RBA I value your thoughts.

  5. Cost pull inflation versus demand driven inflation. Interest rates are an awfully blunt instrument re cost pull inflation. Lots of collateral damage re weak housing markets. Is the RBA brief banking system stability, or fighting inflation?

  6. rate hikes or rate cuts i wonder.
    no need for hikes people are not borrowing, petrol is a hike, food is a hike, we dont wanna see people starve do we?

  7. Isn’t there a political problem here?

    The RBA is clearly focused on the mining investment boom, but the vast majority of voters live in the slow part of the two-speed economy, where house prices are falling, the debt load is monstrous, and they’re saving every penny. They are simply not seeing any of the rivers-of-gold that necessitate higher interest rates.

    As I’ve said before, if the voters ever twig that they are suffering so mining can prosper, the miners might need to increase their advertising budget!