Australian Monetary Policy Preview

June 30, 2008

At 04:30 GMT on Tuesday, the Reserve Bank of Australia will announce results of its July policy meeting.  One can bet the ranch that the cash rate is held at 7.25%.  Like their counterparts in many other economies, monetary officials are balancing excessive inflation against a slowing domestic economy.  CPI data due July 23rd will show inflation remaining above 4%, compared to a target below 3%.  Officials warn that a “significant” slowdown of growth is needed to return inflation to target.  They implemented rate hikes of 25 basis points each in August and November of 2007 and February and March of 2008.  Monetary conditions have been also tightened by Aussie dollar appreciation.  The currency hit a 25-1/2 year high of US$ 0.9667 today, up 3.6% since June 12th and 13.6% from its 2008 on January 22nd.  That incremental restraint in monetary conditions is now producing tangible results in credit growth, the labor market, construction and, most of all, retail sales.

But Australia has a special problem from monetary policymakers.  Growth will be stimulated sharply in 2H08 by tax cuts due July 1st and a leap in the economy’s export/import ratio due to big increases in iron prices.  It remains dubious that the present slowdown of activity will maintain momentum, and the ultimate reduction of growth is unlikely to be as “significant” as officials require.  But in the present world economic environment, wherein financial markets are not back to normal and the risks to global growth remain skewed to the downside,  officials will need proof that more restraint is needed.  At minimum, they will not raise rates before 2Q08 GDP data, which are due in early September can be assessed.  By the same token, a rate cut in the near term is remote.  Indeed, officials are likely to maintain an upside risk on interest rates.  They have laid down two scenarios that could prompt an eventual further rate hike: 1)  domestic demand not slowing as much as expected or 2) excessive growth in wages or expected inflation caused by above-target inflation.  From a policy standpoint, the third quarter of 2008, like 2Q08, will be a period of wait and see.



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