Trend Reversal in Australian Monetary Policy

September 2, 2008

The Australian cash rate was cut as expected to 7.0% from 7.25%, effective tomorrow.  7.25% had constituted the highest rate target since July 1996 and had been in place since March this year.  There had been four 25-bp rate increases between August 2007 and March 2008, three increases in 2006, one in 2005, two in 2003 and two in 2002.  The last time the Reserve Bank of Australia changed rates by an increment of more than 25 basis points was in April 2001, when it was easing.

The statement from August had prepared investors for a rate reduction this month, claiming “scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.”  Only as recently as July did a restrictive rate bias get removed.  Today’s statement still maintains that inflation will be too high in the short term and does not anticipate the restoration of in-target inflation below 3% until some time in 2010.  The mechanism for this eventual drop will be softer demand, but the forecast carries uncertainties because some forces like a sharp rise in Australian export prices and thus incomes will be acting in the opposite direction from growth depressants like tight financial conditions, higher fuel costs, lower asset values, and weaker credit demands by households and businesses.  Today’s statement does not pre-announce the need for cutting rates very soon again, but the likelihood of a move next month is reasonably good given the 7-handle on the target rate.  The statement simply says that the “Board will continue to assess prospects for demand and inflaiton over the period ahead, and set monetary policy as needed to bring inflation back to the 2-3% target over time.”

Australian consumer prices jumped 1.5% in 2Q08 and by 4.5% from 2Q07.  Core inflation is running at 4.4% y/y.  The jobless rate remains quite low at 4.3%, and wages advanced 1.2% in 2Q and by 4.2% y/y.  But employment increased less than 10K on net between April and July.  Retail sales fell 1.0% in June and rose just 3.2% y/y, down from a 6.1% increase in the year to May.  Housing finance is diving.  Housing starts are also clearly in reverse gear.  Consumer confidence is low but rebounded in August.  Motor vehicle sales fell 3.4% in July.  Whereas the household sector is retreating, however, investment (+5.7% in 2Q), profits (+14.3% that quarter), and government spending (up 1.4%) remain buoyant.  The current account deficit of A$ 12.77 billion in 2Q08 was sharply lower in response to an improved terms of trade (export/import price ratio).  GDP growth, due tomorrow, should avoid the red zone.



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