Blog

Borrowers can relax – there’s not much chance of a rate rise any time soon.

Few economic issues receive the amount of public attention that is given to interest rates.

But despite all the energy that goes into analysing every conceivable influence on Reserve Bank interest rate decisions, we are unlikely to see official rates change any time soon. That’s what most experts are saying after the latest measure of price rises across the economy.

The consumer price index (CPI) rose by 0.6 per cent in the first three months of this year, or 2.9 per cent in annual terms, the Australian Bureau of Statistics said last week.

Inflation is important for interest rates because a key goal of the Reserve is to keep CPI growth between 2 and 3 per cent. Its main way of doing this is through ”monetary policy”, or interest rate changes. So on face value, a reading of 2.9 per cent appears close to its upper limit, and should be ringing a few alarm bells at the RBA, right?

Well, it turns out things are a bit more complicated than that.

Containing inflation is a critical part of the Reserve Bank’s job, but that doesn’t mean governor Glenn Stevens will automatically raise rates because inflation is approaching the higher end of its target band.

Although it often gets overlooked, the RBA’s official goal is to keep inflation between 2 and 3 per cent ”on average, over the cycle”. These extra few words are significant. They mean the central bank is prepared to let inflation move about in the short term, so long as it is contained over a longer period of time.

To ensure the RBA is not overly influenced by price changes in goods that are volatile, like fuel for instance, its preferred measure is, therefore, ”underlying inflation”.

And guess what? In the March quarter, underlying inflation was softer than the ”headline” number, rising by 2.7 per cent in annual terms, which is lower than most had been expecting.

This is only a slight increase from the 2.6 per cent rise in underlying inflation during the previous quarter. Therefore, most economists say there should be no urgency in raising interest rates.

After all, the RBA has other responsibilities to consider aside from keeping inflation in check.

Two other objectives in its charter are to maintain ”full employment” and promote ”the economic prosperity and welfare of the Australian people”.

To economists, ”full employment” actually means an unemployment rate of about 5 per cent.

Our unemployment rate is currently well above this, at 5.8 per cent, so economists think the Reserve will be in no hurry to jack up interest rates, which would act as a dampener on the labour market.

It’s also still pretty clear that the economy is experiencing a weak patch because mining investment is declining from extremely high levels.

With the economy still not firing on all cylinders, and inflation rising slower than expected, it’s a safe bet to say interest rates will be on hold for a while yet.

Read more: http://www.theage.com.au/money/borrowing/huff-and-puff-wont-push-up-rates-20140429-37efi.html#ixzz30nJA53jj


Posted by Clancy Yeates – The Age on 4th May, 2014