08/02/2012 - 10:39

Reserve keeps a bit ... in reserve

08/02/2012 - 10:39

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The RBA has an enviable track record but has left many observers perplexed by its latest interest rate decision.

The RBA has an enviable track record but has left many observers perplexed by its latest interest rate decision.

THE building industry was disappointed, retailers were dismayed, and nearly every economist in the country was caught by surprise.

That was the reaction to this week’s decision by the Reserve Bank to leave official interest rates on hold, at 4.25 per cent.

The decision comes against a backdrop of widespread concern over financial difficulties in the eurozone and a weak economy in the US.

Added to adverse sentiment towards the Gillard federal government, the result has been a worrying decline in consumer and investor sentiment.

There was – and still is – a risk that all the talk of doom and gloom will become self-fulfilling, as consumers trim their spending, homebuyers defer decisions, and businesses cut back on investment.

Against that we have a continuation of the extraordinary surge in resources and infrastructure projects in Western Australia and certain other parts of the country, driven by the continued growth in China and its Asian neighbours.

So should we be optimistic, or worried?

If the Reserve Bank has decided that interest rates don’t need to be cut, then surely things can’t be all that bad?

This is the same Reserve Bank that has helped to give Australia a track record of sustained economic growth that is the envy of just about every other industrial country around the world.

The Reserve always has its critics, but it seems to do a pretty good job of balancing the competing pressures it faces.

Governor Glenn Stevens summed up the latest decision with the following comment.

“With growth expected to be close to trend and inflation close to target, the board judged that the setting of monetary policy was appropriate for the moment,” he said.

“Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy.”

In other words, if Australia gets serious economic wobbles, the Reserve will act swiftly to cut interest rates.

Its commentary suggests the interest rate decision was a close call.

It noted that “most forecasters have lowered their forecasts for world GDP growth this year to a below trend pace”.

But it then pointed to some encouraging signs.

Recent data from the US suggest a continuing moderate expansion after a soft patch in mid 2011.

Growth in China has moderated but remained quite robust through the second half of last year.

Commodity prices declined last year “but over the past couple of months have risen somewhat and remain at quite high levels”.

Regarding the financial problems in Europe, the Reserve said the acute financial pressures on banks were “alleviated considerably late in 2011 by the actions of policymakers”.

“Much remains to be done to put European sovereigns and banks on a sound footing, but some progress has been made,” it said.

It observed that, “financial market sentiment, though remaining skittish, has generally improved since early December”.

Critically, the Reserve noted that term funding markets have re-opened, including for Australian banks, albeit at increased cost compared with the situation prevailing in mid 2011.

That contrasts with the pessimists who were worried that wholesale funding would dry up, forcing banks to tighten their lending even further.

On the local front, the Reserve said overall economic growth was “close to trend”, albeit with differences between sectors.

That’s a very restrained way of saying housing construction, tourism, retail and manufacturing are struggling, while resources and energy are booming.

The Reserve said inflation was set to stay around 2.5 per cent and surprisingly played down the rise in the Australian dollar, which is close at an all-time high against the US currency.

“This is largely a reflection of a decline in the euro against all currencies,” the Reserve said.

It would only acknowledge the $A in trade-weighted terms was “somewhat higher” than it had previously assumed.

The Reserve cut official interest rates by 0.25 percentage points in November and December and sees no reason to make a third cut in rapid succession.

That is a big call. For now, we should give the boffins in Martin Place the benefit of the doubt, but if the economy does take a turn for the worse, they had better act promptly.

 

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