Official interest rate policy: could we be wrong?

The Board may today express surprise over current Australian trends. Credit growth, which it wanted to see slow, continues to clock up new multi-year records (see graph); housing approvals and retail sales, which it also wanted to see slow, have been stronger than expected; and the balance of trade has been in greater deficit than official forecasts imply is appropriate. However, quite why there should be any surprise, when monetary policy remains accommodative and fiscal policy is aggressively stimulative, is a mystery.

Overall, the growth of domestic prices, of household debt and the associated current account deficit remain a big worry. If global growth does slow noticeably from current levels, maintaining an Australian policy stance that makes more probable the continuation of strong import growth will be a decidedly risky option.

The Reserve Bank may see itself as finding a “middle way” that relies for its success on faster reductions in asset prices (and the economic slowdown that will inevitably follow) in Australia than elsewhere.  If this is the game-plan, it is a high-risk path. It presumes that future asset price declines are locked in and no further rate hikes are necessary.

In our view, it would be far better to get monetary policy back to a more neutral position as soon as possible.  If sharp asset deflation eventuates, rates can always be cut again.  But at this stage, such an outcome looks unlikely and continued excessively strong growth in domestic demand looks more probable.

Will the Board raise interest rates today?  Don’t bet on it – the Prime Minister would disapprove.