From the AFR comes the next debate about interest rates:
A falling dollar should provide an easier environment for domestic businesses as imports become more expensive and exporting grows easier. It may also limit the need for further interest rate cuts.
But if Australia’s non-mining sector needs a big push, the Reserve Bank of Australia might find it can’t cut rates, says Bank of America Merrill Lynch economist Alex Joiner.
The reason is inflation: a falling dollar makes imported goods and services more expensive. “Despite sub-trend domestic demand, the non-tradeables inflation has remained persistently high,” Mr Joiner said. “If that continued, the RBA might be a little bit restricted in what it can do . . . They wouldn’t be able to cut rates further if tradeables inflation was starting to rise. I guess they could be hamstrung to a certain extent.”
Not all economists agree that the RBA would be “hamstrung” by high inflation in tradeable goods. Westpac economist Huw McKay says the RBA ought to look past imported inflation and cut rates anyway if the economic situation demands it.
UBS economist Scott Haslem says if the dollar slips to US90¢, the RBA would be able to cut rates if necessary, because domestic inflation should ease as productivity improves, wage growth moderates, and the mining boom moves out of its construction phase.
The last two points are right. The RBA has plenty of scope to ignore a tradables inflation spike:
The Reserve Bank of Australia (RBA) is Australia’s central bank, which was continued in existence under, and derives its functions and powers from the Reserve Bank Act 1959. Its duty is to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people. It does this by setting the cash rate to meet an agreed medium-term inflation target, working to maintain a strong financial system and efficient payments system, and issuing the nation’s banknotes. The RBA provides certain banking services as required to the Australian Government and its agencies, and to a number of overseas central banks and official institutions. Additionally, it manages Australia’s gold and foreign exchange reserves.
That’s pretty broad and it just explicitly ignored currency stability for the last five years. Let’s face it, the dollar is falling as we go over the mining investment cliff. Raising rates into this would be choosing to risk depression.
The RBA can and will “look through” an inflation spike. The issue will be how is it prevented from tipping into higher wage claims. I suspect economic weakness will take care of that too but if not the challenge will be that of the new government.
