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Global monetary policy tightens

By Henry Thornton - posted Tuesday, 4 April 2006

Recent economic news strengthens the case that the next move in rates is far more likely to be up than down.

But the big question for Australian economic policy remains as it has been for some time. When will the Treasurer grasp the nettle of serious tax reform?

US Fed Chief Ben Bernanke produced no suprises following the recent meeting of the Fed’s policy-making committee. Cash rates rose to 4.75 per cent and the language changed few if any minds about the prospect of at least one more increase. Indeed, it seems that the words were slightly more aggressive than the average expectation, and this produced a stronger US dollar, higher bond yields and a mild reduction in US equity prices.


Record low US cash rates have now been corrected, and the gap with Australian cash rates has narrowed dramatically - see graph. One consequence is that the Australian dollar has taken a dive from the high 70s to the low 70s. No drama yet, but this is an important indicator, a modern monetary equivalent of a canary down a mine. And this canary is looking a bit wobbly on his perch.

This mild negative surprise from the US Fed was not mirrored elsewhere. Asian and European shares continued their recent rises. The prices of oil, gold, other precious metals and copper rose further. The flow of stories about the latest round of iron ore price negotiations became more positive and it seems China’s rulers have abandoned their rumoured attempt at old-time price control in this area. Nuclear power is suddenly being looked at less negatively, and Australia has about 40 per cent of the world’s known deposits of uranium. Resource stocks reached new highs.

In the United States, it was weaker than expected housing data that led some on Wall Street wrongly to predict softer Open Market Committee rhetoric. Overall, however, US data has continued to indicate economic strength. China is growing strongly, while in Japan and Europe recovery is strengthening. The overall prospect is for continued exceptional strength in global growth.

Risks remain - the Middle East is in a ferment, bird flu continues to worry many people and some economists believe US housing will induce a slowdown there. But for the present one can say monetary policy should not be used in attempts to offset problems that may never eventuate. The prospect is therefore for increases in global interest rates, with almost all central banks tightening, or thinking about tightening.

In Australia, ABS job vacancies rose by 4.7 per cent in the February quarter, just shy of the record highs reached in early 2005, and this bodes well for employment in the rest of 2006.

Retail sales for February also surprised on the upside, rising 0.7 per cent in February compared with predictions of 0.3 per cent and a strong (revised) 0.9 per cent per cent in January.


Aggregate credit growth also seems to be rising again. Credit growth probably bottomed at around 13 per cent per annum in early 2005 and has risen to 14 per cent in the year to February 2006, led up by lending to business, running at 16.5 per cent per annum.

Total credit growth of 14 per cent is rapid in an economy growing at a nominal 5-7 per cent per annum pace, and is one factor leading analysts to revise up their forecasts for Australian GDP growth in 2006 and 2007.

Profits are high, skilled labor is scarce, fixed capital spending is expanding strongly and aggregate demand is being supported by the strong terms of trade. Growth in business demand for credit is more likely to increase than to slow from here.

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First published in The Australian on April 4, 2006 and on Henry Thornton's website.

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About the Author

Henry Thornton (1760-1815) was a banker, M.P., Philanthropist, and a leading figure in the influential group of Evangelicals that was known as the Clapham set. His column is provided by the writers at

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