The Australian dollar was pushed over 96 USc yesterday after the Reserve Bank used the minutes from its May 6 board meeting to put an interest rate rise back on the table, with the strong warning that one is in the offing if demand doesn’t continue to slow.
The minutes of the meeting show a key phrase was not included in the statement after the meeting earlier this month.
That statement issued by Governor Glenn Stevens after the meeting said in part, where the outcome was being discussed:
"On balance, the Board’s current assessment is that demand growth will remain moderate this year. In the short term, inflation is likely to remain relatively high, but it should decline over time provided demand evolves as expected. Should demand not slow as expected or should expectations of high ongoing inflation begin to affect wage and price setting, that outlook would need to be reviewed."
But the minutes show that a rate rise was actively discussed by the board.
"The question therefore remained whether the setting of monetary policy was sufficiently restrictive to secure low inflation over time.
"Members spent considerable time discussing the case for a further rise in the cash rate.
"But on balance, given the substantial tightening in financial conditions since mid 2007, and the extent of uncertainty surrounding the outlook, the Board decided that it was appropriate to allow the current setting of monetary policy more time to work.
"However, should demand not slow as expected or should expectations of high ongoing inflation begin to affect wage and price setting, the outlook, and the stance of policy, would need to be reviewed. The Board would need to evaluate prospects for economic activity and inflation in the light of incoming information."
There was no mention of any discussion about a rate rise (although you’d have to believe one would have been mentioned).
The mention in the minutes of a discussion about a rate rise is similar to the discussion in the February minutes about whether the bank would lift rates by 0.25% or half a per cent in February. It went for 0.25% but came close to half a per cent, which took the market by surprise. It followed up with a 0.25% rise in March, which some economists and commentators (and certainly the Federal Opposition) reckoned was one increase too many.
But now there’s a further increase on the agenda and with the Australian dollar trading well above 95 USc for the second day in a row (the first time that has been done for 24 years), the currency was buoyed by the details of the RBA minutes.
In fact the dollar jumped from just under 95.40 USc to above 95.70 USc and a new 24 year high in the minutes after the RBA released its detailed minutes of the May 6 meeting. It then rose further, peaking at 96.19 USc in US before settling back at just over 95.80. It was around that level in New York this morning.
The minutes show the extent to which the board discussed the inflation problem and fears it was becoming entrenched and damaging the economy.
"Board members noted the importance of reducing inflation if Australia was to avoid a prolonged period of economic difficulty. The staff forecast was that inflation would return to the target by the end of the forecast period in 2010, if the recent slowing in demand was sustained.
"This would most likely be associated with output growth falling to quite low rates in the year ahead, something that was required to ease pressure on capacity and slow the pass-through by businesses of higher input costs.
"Even so, members noted that the forecast path for inflation involved it remaining above 4 per cent for much of 2008. This carried the risk that expectations of high ongoing inflation could develop, which could in turn affect price- and wage-setting behaviour."
And the Reserve Bank received strong backing from Federal Treasury secretary Ken Henry who told a Sydney lunch yesterday that the Australia’s inflation targeting system is very important to help anchor inflation expectations in the community.
"The case for having a medium term monetary policy target is that it helps anchor inflation expectations," Dr Henry said during a speech at an Australian Business Economists function in Sydney.
"Managing inflation expectations is especially important when the economy is growing strongly and is especially important when the economy is being hit by external shocks to domestic prices."
Without a secure anchor, the level of consumer expectations might feed into wages claims and possibly a wage price spiral, Dr Henry said.
"We’ve seen this kind of thing before," he added.
Dr Henry said those who questioned the 2-3% inflation target used by the central bank were ”seriously misguided".
He said "There has been some question in recent times over the appropriateness of the inflation regime.” Those questions were "misguided" and "peculiar", said Australia’s leading bureaucrat.
"Our inflation targeting regime has served us well,” Henry said. And arguments that this regime should be discarded, "should be rejected", he added.
But he said that we have to "do better" if we are to successfully manage the impact of a sharp rise in our terms of trade this year.
He also made it clear the $41 billion in infrastructure funds created in the budget would not become a slush fund and would be taken into account when working out the surplus in the year that they were used.
