RBA dilemma

Minutes from the RESERVE BANK OF AUSTRALIA (RBA) meeting on the May 6 2008 reveal that as CPI figures had continued to disclose higher inflation than anticipated, the RBA was seriously considering increasing interest rates this month.

There had been extensive debate over the issue and ultimately it was felt that the monetary policy was "sufficiently restrictive to secure low inflation over time" given inflation was forecast to remain above its target band of two to three per cent over the medium term until 2010.

"But on balance, given the substantial tightening in financial conditions since mid-2007, and the extent of uncertainty surrounding the outlook, the board decided that it was appropriate to allow the current setting of monetary policy more time to work."

The Australian dollar hit a fresh 24-year high of US95.87 cents after the RBA statement as some traders bet on higher interest rates.

Brian Redican, a senior economist with Macquarie Group, said while another rate rise in June was unlikely, a hike in August was still possible.

"The RBA is still considering whether to raise rates again, but at the moment, it will probably wait and see what happens to domestic demand and inflation," he said.

Money market traders say there is a good chance of an August rate rise but do not expect a rise next month. If inflation figures for the June quarter remain high, then the chance of an August increase will firm.

Ultimately the RBA left the official cash rate unchanged at 7.25 per cent but nevertheless remained wary of demands for higher wages and increased prices. If demand does not slow down or begin to affect wage and price setting would need to be reviewed. The RBA currently sets interest rates to maintain inflation between 2 and 3 per cent. The Board minutes said that with inflation remaining above 4 per cent for most of 2008 there was a risk that expectations of high ongoing inflation could develop. This could in turn affect price and wage setting behaviour.

In its quarterly statement on monetary policy the RBA said they expected an annualised inflation rate of 4.25 per cent by June and 4.00 per cent by December. The central bank also projected CPI to decline from around 3.25 per cent in 2009 to 3.00 per cent in 2010. In March quarter of this year, annualised underlying and CPI clocked in at 4.20 per cent.

Despite weaker household spending and weaker demand for credit for both households and businesses CPI and underlying inflation had risen to uncomfortably high.

The RBA repeated previous statements that were "powerful opposing forces affecting the Australian economy."

Published on May 5-st, 2008 in Financial Planning
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.