It's arguably one of the most difficult times in recent history to be on the board of the Reserve Bank of Australia. Part of the reason for that is that their decisions are not clear cut. That is, there's not necessarily a right or a wrong way to shape policy at present. Another reason is that they have to be pre-emptive rather than re-active. In other words, you tackle inflation before it's starts running away, because once it's away (running down the sidelines) an 'ankle tap' is your only hope of stopping or controlling it.
Today's decision to leave rates on hold is a prudent one. The board is well aware that the economy is really only being held up by the resources sector and the associated private sector investment that's going with it. Other parts of the economy including retail spending, manufacturing and services are all struggling. That's partly to do with weaker consumer credit and increased savings rates and also the higher Aussie dollar.
Consistent with all their decisions, the board focuses on inflation. The threats to inflation may come from the employment market (with rising wages), or from the rising cost of utilities, fuel, rents or fruit and vegetables. Fact is though none of these areas have 'broken out'. They all remain constrained - elevated, sure, but still constrained. In addition, it's highly likely the cost of fruit and vegetables will fall once the temporary supply-side effect of the recent natural disasters in Queensland abates.
A weaker construction sector, services sector and moderating credit growth amongst consumers all make it more difficult for the RBA to raise rates in the short term. The questions remains, if the economy picks up as many economists are predicting it will, will the Reserve Bank have to raise rates at precisely the time that it will be most unpopular to do so? That could be as early as August. A rate hike then would be in anticipation that a resumption in the resources boom will coincide with falling employment and rising credit growth amongst consumers.
I really don't believe the RBA needs to be in any hurry to tighten rates. While we are likely to see GDP growth return close to trend levels, the Australian economy is significantly leveraged to the global economy, and that is still creaking and groaning. Another rate hike in the short term would push up the value of the Aussie dollar and further harm the manufacturing sector - a sector that's vital for sustainable economic growth.
A basic rule is that if it ain't broke, don't fix it. The economy is in what I would call a 'stable condition'. It's not looking particularly healthy but it's not critical either. A wrong move one way or the other, would be more destabilising than we think. Let's wait for those inflation figures to come out to determine where the real pressure is coming from. Then we can make an accurate assessment on whether those price pressures are likely to remain with us and hence if they need to be controlled by tightening policy. Otherwise, leave the economy alone!
Rising prices may need to be managed, but the Reserve Bank needs to be aware that in a multi-speed economy, one blunt instrument with a time-lag in its implementation, needs to be treated with great caution.
David Taylor
