Nov 082007
 

Let’s take a gander at just what Glenn Stevens had to say on behalf of the Reserve Bank of Australia board yesterday.
over the fold…

Statement by Glenn Stevens, Governor Monetary Policy RBA
Inflation in Australia has increased. Underlying inflation was 0.9 per cent in the September quarter and close to 3 per cent over the past year. The annual pace of CPI inflation was lower, but this reflected two very low quarterly results nearly a year ago, as well as recent changes to the treatment of child care costs. By the March quarter of next year, both headline and underlying measures of inflation are likely to be above 3 per cent.
During 2007, the pace of growth of demand and output has also increased. There are few signs of that strength diminishing as yet, and reports of high capacity usage and shortages of suitable labour persist. Growth in labour costs has been contained so far, and high levels of investment are adding to productive capacity in some sectors. The rise in the exchange rate will help to contain pressure on prices. But growth in aggregate demand will, nonetheless, need to moderate if inflation is to be kept to 2‑3 per cent in the medium term.
In reaching its decision, the Board continued to look carefully at developments in international financial markets. Conditions have improved over the past couple of months, but confidence remains fragile. Funding costs for intermediaries remain elevated relative to official interest rates, and capital market conditions are still difficult, in several major countries. This is likely to result in some moderation in growth in those countries in 2008, and forecasts for global growth have been revised down accordingly. The world economy is still expected to grow at an above-average pace, however, led by strong growth in China and other parts of Asia. High global commodity prices remain an important source of stimulus to Australian spending and activity.
In Australia, the tightening in credit conditions resulting from the global turmoil has been less pronounced than elsewhere. Wholesale funding costs have risen a little compared with official rates, and some borrowers have experienced an increase in interest costs as a result, but the flow of credit to sound borrowers does not appear to have been impaired.
Having weighed both the international and domestic information available, the Board judged that a further increase in the cash rate was needed now in order to contain inflation in the medium term.

I’ve highlighted the sections which I felt were most pertinent. These sections make references to, and inferences about where the Bank is likely to be heading in the coming months, December 2007 to February 2008. Clearly, inflation is the Board’s major bugbear and it states as much in the first para, albeit recognising the false dichotomy created by later quarters of 2006 and alterations to social costings. The warning is very clear.

“By the March quarter of next year, both headline and underlying measures of inflation are likely to be above 3 per cent.”

I read this sentence to indicate that the Board expects current resources demands from China, to which the Australian economy is tied for it’s current growth, to continue unabated. This demand will continue to place pressures on supply of skills and labour which are inadequate, thereby forcing higher wages to be paid in the resources and closely related sectors in order to attract suitable skills and labour. The implications on cost-of-living inflationary factors are inescapable. The only tool available to the RBA is monetary policy and blunt instrument that it is, monetary policy is ultimately effective in stopping growth. Notice, I say ‘stopping’ not ‘slowing’.
Yesterday’s twenty-five basis point bludgening of domestic cash rates is not the interest rate rise that borrowers need to be wary of. It’s the impending rises due in Early 2008 which will have the most impact on Australia’s economy, the first of which is likely in March following the February release of December-January CPI results. Standard Home Loan variable rates, following yesterday’s cash rate increase, will move upward to 8.55% from the current 8.32%. The major banks are announcing fixed rate increases of between 0.10% and 0.20% to their schedules as of Monday. This is NOT to counter the cash rate increase but to recoup losses already incurred throughout September and October as a result of the U.S. sub-prime fraca sweeping the globe. With the presumed ‘flight to safety’ most lenders expect to happen as home loan borrowers seek to shield themselves behind fixed rates, you can expect demand for fixed rate money to force those rates upward again, and soon.
Where does all this presumed doom and gloom leave the Australian finance marketplace? Activity will slow, there’s nothing surer, but as with the pre-cursor to the so-called recession we had to have, those who need to borrow will continue to do so. As the RBA Board states “the flow of credit to sound borrowers does not appear to have been impaired” and it won’t be. Prudentially, Australia has a solid system of credit risk analysis. Borrowers will still borrow and lenders will still lend, but at lower levels as monetary policy weighs in. Will we see a recession in the future? Well, from my perspective these events always…..always, run in cycles. Some booms and busts are bigger and more spectacular than others, but cycles always return. The only element of our economy protecting Australia at the moment is the failing U.S. economy, resulting in our dollar rising to off-set many of the cost-of-living impacts we’d otherwise be feeling. Can you imagine, reader, what the price of a litre of petrol would be at the bowser if the A$ wasn’t sitting at US$0.9376?
I’ll leave you to ponder those thoughts and the implications ahead of our current situation.