Asia and Pacific

Comment: RBA raising rates because they can?

Monday May 14, 2012

The announcement by the Reserve Bank of Australia that it is raising interest rates by 25 basis points is stupefying. This is a strong statement from an author who generally has a lot of respect for the monetary policy system in Australia, which doesn’t use inflation as its sole target.

The objectives of the RBA in terms of legislation are to ensure exchange rate stability, maintain full employment, and contribute to economic prosperity and welfare of the people of Australia.

Since 1993, the RBA has aimed to do this by keeping inflation broadly between the 2 percent and 3 percent range using interest rate changes. But the focus has always been on the three objectives mentioned.

All of which makes the reasons given for the cash rate rise in the RBA Monetary Policy Media Release of 6 October mind-boggling.
GDP growth for 2010: The RBA believes Australia’s main trading partners are likely to grow close to trends in 2010, and that the result will be growth for Australia close to trends in 2010. The 10 nations on the chart account for 77 percent of Australia’s merchandise trade, and have a weighted average forecast GDP growth of 4.2 percent for 2010.

This may well be the case, but should this alone be sufficient for a rates rise? The crucial question left unanswered in the RBA Statement is whether this return to growth will undermine any of the three objectives of the Act, or will push inflation (as the blunt indicator used) beyond 3 percent in the medium-term.

Unemployment: The RBA cites unemployment not having risen as far as expected as one nail in the coffin of lower interest rates. It’s true that unemployment is not at 10 percent as in the early 90s, but we’re certainly not talking full employment.
Given the other objectives of the RBA discussed below and above, and while unemployment remains above 5 percent, we really can’t see any major reason to start lifting the cash rate.

nflation: According to the RBA’s August Monetary Policy Statement, the CPI is expected to rise by between 2.00 percent and 2.75 percent annually in each of the five six-month periods to December 2011.

Granted, that Statement is two months old and, in today’s fast-paced world, the RBA may believe stronger world demand may mean stronger inflation. So add 50 basis points to each of these forecasts, and we still have an average CPI of around 2.7 percent over the medium term of 2.5 years – well within the target band.

Even underlying inflation, which is creeping into RBA vernacular as a better measure of inflation, was estimated to average around 2.35 percent over the next 2.5 years in August. Crank that up 50 basis points, to 2.85 percent, and once again, we’re still within the band.

Housing credit rising, business borrowing falling: Neither of these facts point to a need for raising rates. Housing exclusively is not a concern of the RBA, as we often remind our own central bank. And business borrowing falling is a real concern. The Statement assures us that large firms have improved access to credit, but it sounds like businesses in Australia may be battling the same difficulty as in New Zealand. Banks are not cutting lending rates to small and medium businesses nearly enough.

Banks have already priced cash rate rises into fixed-rate loans: Who’s the head and who’s the tail? Perhaps this author is just naïve, but isn’t the RBA the one who gets to set the terms, and not the commercial banks? Ah well, the banks are already assuming higher rates and milking their clients, so we might as well take it up a notch and complete the self-fulfilling prophecy.

Exchange rates: The A$ has risen an average of 30 percent against major trading partners since February. The RBA acknowledges that this will “dampen pressure on prices and constrain growth in the tradeables sector”.


With currency stability as one of the three objectives of the Act, we ask again why the RBA would be looking to raise rates at this point. This is only likely to make speculative investment in Australia that much more attractive as the cash rate comes into line with commercial bank expectations of rates rises.

It seems the RBA’s decision this week was more about getting the cash rate up from historical lows as quickly as possible, as if that is an uncomfortable area to be in. It is hardly a liquidity trap as the US is in. It seems to be a matter of raising rates for the sake of raising them, simply because they can.