Fed: Overheating risks to keep RBA's hand poised over rate lever

AAP General News (Australia)
04-09-2010
Fed: Overheating risks to keep RBA's hand poised over rate lever

By Colin Brinsden, Economics Correspondent

CANBERRA, April 9 AAP - If we have learnt nothing else this week, we now know that
when Glenn Stevens talks about the need to gradually lift interest rates, he's means size
rather than frequency.

Although financial markets had started to lean towards a rate rise this week - especially
after Reserve Bank of Australia (RBA) governor unexpectedly popped up on breakfast TV
- there was still a cluster of economists who took "gradual" to mean at least alternate
board meetings.

And you can see why they stuck to their guns after a run of fairly limp data in the
weeks before Tuesday's meeting of the central bank board.

February retail trade dropped 1.4 per cent, February building approvals fell for a
second straight month, down 3.3 per cent, and earlier released February employment grew
by just 400 workers.

In fact, Thursday's labour force report for March showed that the February outcome
was downgraded to a 4,700 fall, the first drop since August 2009.

Still, just days before his pre-recorded interview with Sunrise's David Koch was screened,
Stevens as good as told a Sydney audience that when it comes to rate decisions we should
expect the unexpected.

He had never vowed to make rate changes that wouldn't surprise financial markets or
borrowers more generally, he said.

February's decision to leave the cash rate unchanged is a case in point, as most expected
the central bank to return for the summer break with its hand firmly on the rate lever.

"We have certainly never made a commitment not to make surprises," Stevens said.

"And nor should we, nor should any central banks."

In the end, the majority called this week's rate decision correctly with the RBA lifting
the cash rate for a fifth time in seven months, taking it to 4.25 per cent.

Interestingly, the governor's accompanying statement to the rate announcement dropped
the words "flexible" and "gradual", leading some economists to expect yet another rate
rise in May, particularly as he didn't appear to baulk at February's soft run of data.

"The board judges that with growth likely to be around trend and inflation close to
target over the coming year, it is appropriate for interest rates to be closer to average."

Tuesday's decision was "a further step" in that process.

Stevens and his team repeatedly have pointed for the need to get lending rates back
to "average", suggesting that at least another 25 basis point increase is on the cards
in the next month or so.

But his latest statement was particularly upbeat, suggesting that there are likely
to be even more hikes after that.

He noted that Asian growth had continued to be quite strong, contributing to pressure
on prices for raw materials.

This in turn will lift Australia's terms of trade, adding to incomes and a build-up
in investment in the resources sector, and lead to output growth over the year ahead exceeding
that of the previous 12 months.

This strength comes despite the diminishing effects of earlier stimulus measures.

The unemployment rate has also peaked at a much lower level than earlier expected and
the declining pace in business lending has lessened.

Housing credit had expanded at a solid pace, albeit moderating in recent months as
interest rates rose and the impact of the government's more generous first home owners
grant tailed off.

"Nonetheless, at this point the market for established dwellings is still characterised
by considerable buoyancy, with prices continuing to increase in the early part of 2010,"

Stevens said.

RBC Capital Markets senior economist Su-Lin Ong said his pointed comments on the housing
market suggests this would be a key factor in future RBA deliberations.

"Jawboning from the RBA on the housing front is likely to continue, and while there
are a number of factors underpinning the strength in house prices, the still modest level
of mortgage rates is clearly a contributing factor," she said.

Whether or not the central bank lifts rates once or twice in the next three times,
this is unlikely to be the end of the policy tightening process.

Macquarie Bank interest rate strategist Rory Robertson believes Mr Stevens is worried
about a rerun of economic "overheating" along the lines experienced in 2007/08.

Unemployment then fell to four per cent and underlying inflation started running at
an annualised rate of four to five per cent.

"Sooner or later the RBA almost certainly will find what it sees as good reasons why
policy 'normalisation' is not enough," he said.

The RBA was focused on the risk of much stronger wage and price pressures in the next few years.

"If things continue to unfold as policymakers expect - with high-growth Asia continuing
to fuel resource prices, our giant mining boom, above-trend economic growth and lower
unemployment - it's easy to see the RBA hiking from 4.25 per cent today to 6-6.5 per cent
by the end of next year," he said.

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