Australian Monetary Policy Tight But on Hold

May 6, 2008

The last four Australian interest rate hikes in Aug 2007, Nov, Feb and March 2008 coincided with a global financial market crunch from which Australia was not exempt. As a result, authorities at the Reserve Bank of Australia shifted their policy bias to neutral in April, observing then that monetary conditions since mid-2007 had tightened “substantially” and predicting that such would lead to the significant slowdown in aggregate demand that Australia needs if inflation is to settle back into target. The central bank today left its cash rate at 7.25% as it did in April compared to a cyclical low of 4.25% in early 2002. But today’s statement expresses less confidence than April’s that the baseline forecast will prove correct. Officials admit that Australia’s terms of trade (export/import price ratio) is rising by more than had been expected. For a commodity producer like Australia, that stimulates growth. The statement does not mention a huge tax cut that will be produce a second growth driver later this year but concedes that “opposing forces” are at work on demand, creating considerable “uncertainty” over the outlook for both demand and inflation.

There is still no chance of a near-term rate hike. The statement speaks about “accumulating evidence” of the predicted slowdown in demand, without specifically mentioning that retail sales volume fell by 0.1% in 1Q08 or that full-time jobs grew merely 4.4K during the last quarter. But with core and headline inflation climbing further above target, the hedged forecast serves notice that 7.25% may not be the eventual central bank rate’s peak. Like Keynes, officials reserve the right to change opinion if future facts deviate from what is being assumed.



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