04/11/2010 - 00:00

Reserve Bank has runs on the board

04/11/2010 - 00:00

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Interest rate increases are never welcome but the Reserve Bank’s track record needs to be respected.

The Reserve Bank of Australia lobbed a small surprise this week, announcing a 25-basis-points increase in interest rates just before the Melbourne Cup was due to commence.

The timing was unexpected but not the direction; the Reserve has previously signalled that the next move in interest rates would be up.

Its decision was immediately met with cries of dismay, only fuelled by the commercial banks’ decision to lift their lending rates by more than 25 basis points.

The Commonwealth Bank was first to make that move, lifting its lending rates by 45 basis points.

Like the Reserve Bank, it had also signalled its intentions clearly, stating previously that funding costs had increased by more than the rise in official rates, and therefore action was needed to preserve its margins.

Comments from the big banks on funding costs triggered a warning last week from Australian Competition and Consumer Commission chief Graeme Samuel, who declared “price signaling” in public statements was a growing concern.

That issue represents a long-term policy challenge but in the short-term there has been more talk about the Reserve’s latest move.

The Australian Retailers Association, for instance, said its members were devastated by the Reserve’s decision.

“History tells us that when consumers have to deal with increased mortgage repayments in the few months before Christmas it has disastrous impact on retail trade during the festive season,” ARA executive director Russell Zimmerman said.

“This is a heavy handed and unnecessary decision that could have been delayed especially considering the current low inflation rate and the strong Aussie dollar.”

Treasurer Wayne Swan joined the bashing exercise, focusing on the Commonwealth rather than the Reserve.

“This is a cynical cash grab by the Commonwealth Bank, there's no other way to look at it,” he told reporters in Brisbane.

“I believe there will be a substantial backlash against the Commonwealth Bank as there should be.”

Opposition treasury spokesman Joe Hockey, who has called for a major review of the banking sector, said Mr Swan was to blame for overheating the economy.

“The government has now lost control of the economy, the government now owns these rate increases,” he said.

CommSec chief economist Craig James said the timing of the move on Melbourne Cup day was appropriate since it was taking a punt on a rate hike.

“The latest data shows inflation under control and many parts of the economy going backwards, so the Reserve Bank is taking a risk in lifting interest rates at this current point in the cycle,” he said.

“Many Australians will feel that the Reserve Bank has lost touch with the average consumer and business person but we have to remember that our central bank has guided the economy for 20 years without a recession.”

The Reserve Bank acknowledged in its statement this week that its outlook for the economy and inflation was largely unchanged from earlier forecasts.

It also acknowledged differences in the economic strength of various industries and regions.

In addition, the Reserve Bank noted the economy is now subject to a large expansionary shock from the high terms of trade and has relatively modest amounts of spare capacity.

That is an economists’ way of saying that high commodity prices are fuelling a resources boom and as a result we are facing labour shortages.

That means there is a continuing risk of inflation rising, which can best be addressed by a modest rise in interest rates.

The bank summed it up this way: “At today’s meeting, the board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent”.

There will be some short-term pain but if history is any guide, the Reserve Bank’s policy settings will help to achieve consistently positive results in the long-term.

 

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