RBA Day – Don’t Hike.

August 2, 2011

FOREX, RBA and Interest Rates

One month’s meeting should never really matter given the leads and lags of monetary policy and the impact on the economy. This is certainly the case when the only reason for a move is that you have an acceleration in inflation based on one-off factors or factors that interest rate moves will do nothing about.

We have written much on the weakness in the domestic economy and it is clear that we have a fundamental difference of opinion in our view with what is happening in the households of Australia and what the RBA believes is happening. We hold that this increase in savings is structural as Australian reduce their debt burden and try to get their balance sheet back to a place they feel more comfortable with and which they believe is more sustainable.

While I know that it is hard to fit this into an equation for the classically trained economists for those of us with a “behavioural economics” bent it is something that we must factor into our expectations. Quite frankly we don’t understand why if this, reduce debt and repairing balance sheets, is what Governments are doing all over the world as a rational way to ensure long-term survival why is it not understandable that given the structure of Australian balance sheet debt households do the same – think of it as “Austerity Australian Style”.

So we come to this meeting with 4 of 25 Bloomberg surveyed economists calling for a rate hike. We are fairly certain the RBA staffers will be worried about a rerun of the 2007-2008 experience which was no fun for anyone who worries about inflation. But for me the key here is that monetary policy is not going to be able to do anything about the rise in prices coming from things like utilities or mother nature. However there is much damage that more interest rate hikes will do to the domestic economy and while you hear that another 25 basis points doesn’t add much to the cost of your average mortgage in aggregate over the just under $1.2 trillion dollars in debt it will take around $3 billion out of the economy, out of retailing. There is never a rush with monetary policy and with growth weak in Australia there is no rush now.

Take for example yesterdays data which I covered here. Manufacturing and Housing are getting absolutely decimated. We saw last week that the RBA credit aggregates are pointing to a lack of appetite for debt and the lack of spending has been in evidence for all to see for some time. The domestic economy and households are in a funk buffeted by too much debt, a high interest burden, the casualness of labour which undermines stability and increases job insecurity, and rising prices on the high visibility items. I personally think the domestic economy is holding up really well in the face of these headwinds and Australians should be congratulated for their optimism – because it could be far worse.

There are those in the punditry and the commentariat who today are saying that with the seeming resolution of the US Debt problems and with a hiatus in the worsening in the European situation that things are settling down.

But think about the long run impacts of these messes, debacles or whatever you want to think of them. People now know that they can not necessarily trust their political leaders to deliver on the entitlements they expect when they get old. Provision of a safety net in retirement has been one of the triumphs of capitalism and the consumer society. It has allowed populations to reduce their savings and spend, spend, spend in the consumption years of their lives knowing that the worst case is the Government will look after them if need be.

As a behaviouralist I think this is the biggest casuality of the last couple of years of the crisis. The initial period where global banks and the banking system needed to be saved was scary enough but now populations know that perhaps, just perhaps, the money won’t be there for their retirement.

The implication – higher savings rates across the developed world for the long-term. This also means that aggregate demand is likely to be lower in the developed world in the future as well.

Certainly Australia is lucky in that we are in the right hemisphere to capitalise on the rise of China, India and Asia more broadly and this is doubly so because we are selling them what they need to develop. But the transformation of the Australian economy that is inevitable does not have to happen in a very short window and without regard to the internal transformation that is also happening in Households. They are making way for the mining boom, it can be accommodated.

So I hope that the RBA remembers that there is never a rush on any one month to raise rates. Lets see what inflation looks like in a few months time. If it is accelerating and crucially if it is feeding into wages claims raise rates then. Or be creative like Governor Macfarlane was many years ago. Why not hold off on rates now and if wages claims start to increase threaten to increase rates to offset the increase as he did. It worked once, I’m sure it will work again.

Monetary Policy might be a big stick – but there’s always a sharp edge somewhere.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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