Don’t expect this rates holiday to last forever: Bartholomeusz

There was never any serious expectation that the Reserve Bank would lift official interest rates yesterday. In announcing the decision to leave the cash rate at 4.75%, however, the Reserve Bank governor, Glenn Stevens, was remarkably sanguine about the state of the nation and the world.

Only three months ago the central bank made the decision that, with hindsight, shocked the nation (or at least consumers) when it raised rates by 25 basis points knowing with near-certainty that the major banks would lift lending rates by a materially large amount. It did so because it was concerned that the income shock from the record terms of trade and the relative dearth of spare capacity in the domestic economy would eventually ignite inflation.

Yesterday, despite referring to the continuing concerns about sovereign creditworthiness in Europe, the RBA appears comfortable that the global economy is going to grow strongly this year and that commodity prices, which have been driving the dramatic increase in the terms of trade to their highest levels since the 1950s, will also remain strong and underpin continuing growth in national income.

While private investment is responding to the commodity boom, the household sector – perhaps because of the November rate rises – are spending and borrowing less and saving more. Credit growth, Stevens said, was quite subdued despite evidence of some greater willingness to lend.

Despite strong employment growth and some growth in wages last year and an expectation of further growth in both this year, the banks appear far more comfortable with the outlook for inflation now than it was in November, or even in December, when it was still musing about the medium-term prospect of higher inflation.

Now, after a lower-than-expected December quarter CPI increase, the bank expects inflation this year to be consistent with its 2% to 3% target range, with the firm Australian dollar and strong competition in “some key markets” (retailing?) helping to keep it under control.

Despite last year’s wages growth, after a significant decline in wages growth in 2009, the bank appears unconcerned about the prospect of a wages break-out, despite the shortage of skilled labour and the vast pipeline of major resource and infrastructure projects.

The floods are a fleeting and relatively modest phenomenon, with some lost production and lower growth in the affected areas and some impact on commodity prices, which the bank would, when setting monetary policy, “look through” as it remained focus on the medium-term outlook.

The rehabilitation of the affected areas will, over the next few years, also add “modestly” to aggregate demand but was unlikely to have an impact on the medium-term outlook for inflation.

There is nothing in the statement to suggest the bank is contemplating another rate rise anytime soon, indeed the language tends to suggest it doesn’t see anything on the horizon this year that would cause it to move again.

Maybe that’s because of the extent to which the November rises appear to have scared consumers and added to the intensity of price-based competition between retailers which has seen them coughing up all the benefits of a strong Australian dollar plus margin to maintain volumes. The flood levy will also have an impact on consumers, although in reality for most it will be more psychological than financial.

But given the degree of investment planned this year, the lack of excess capacity in the economy, particularly in the labour market, and the apparent strengthening of the recovery in the global economy, which is being fuelled by the extraordinarily expansive monetary policies being pursued by the US and Europe, it would be very, very surprising if we got through this year – or even this first half – without another increase.

It would be more than surprising. It would be disturbing, because it would signal that, despite the resources boom and its associated investment spree and despite the improving global economy, for some reason (or reasons) the Australian economy wasn’t behaving – it wasn’t growing – as one would expect it to in those circumstances.

Despite the RBA’s apparent comfort with the current economic settings and outlook, however, that remains an unlikely outcome.

This article first appeared on Business Spectator.