Australian Central Bank Signals No Rate Changes Just Ahead

July 1, 2008

In the vernacular of central bank watching, officials send hawkish, neutral, or dovish signals, wherein “hawkish” connotes a predisposition to raise interest rates and “dovish” a bias to cut them.  Officials at the Reserve Bank of Australia had been hawkish for several years, lifting rates in 13 steps between May 2002 and March 2008 by 300 basis points in all to 7.25% and by rather consistently warning of a greater possibility of rate hikes than cuts.

After leaving the Australian cash rate flat at 7.25%, officials released a statement today, which has been labeled by analysts as “dovish.”  Actually, such was neutral, since no hint of a rate reduction is provided.  But “dovish” captures the statement’s tone, because several changes from earlier statements were made that convey a reduced chance that any further rate increases should prove necessary.

  • Credit concerns have resurfaced, intrinsically tightening financial market conditions and depressing the outlook for growth.
  • Labor market conditions shows “tentative signs of easing.”  Wage-push inflation associated rising expected inflation is a more remote danger.  The statement in June warned that “should expectations of high ongoing inflation begin to affect wage and price setting,” the outlook for moderating growth would need to be reviewed.  That explicit warning is not included in the new statement.
  • The short-term outlook for CPI inflation has worsened from “remaining relatively high” to being “boosted further in coming quarters by the recent rises in global oil prices.”  But officials do not believe such will lift expected inflation if growth weakens as expected.

Officials have not changed their forecast that total and core inflation (excluding food and energy) decline over time.  Above-target inflation will be overlooked so long as growth slows as much as officials expect.  And if that happens, rates have likely peaked.  I infer this from the assertion in both June and July that the current policy stance is “appropriate,” which implies sufficient to restore in-target inflation in the medium term.  But there is a rub, that officials have not abandoned.  The economy will be stimulated in 2H08 by stronger export prices, which boost incomes, and tax cuts.  A possibility exists that growth will not slow as much as officials think is necessary. Policy in 2H08 will be more sensitive to trends in economic activity — the feedback on this question — than inflation, which officials concede will be unacceptably elevated in the near term.



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