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Time to cut RBA rates, but easy does it

By Henry Thornton - posted Tuesday, 2 September 2008


The Reserve Bank is widely expected to start the easing process today, as it is fairly confident that inflation will be down to its target range by 2010.

At the same time, business and household confidence is low, credit growth has slowed and even the job market has shown signs of weakness, but no more (so far as anyone can tell) than the modest slowing allowed for in official forecasts.

Asset markets are where the signs of stress are most evident. Equity prices everywhere have fallen a long way. Experts are trying to pick the end of the correction, but there is no agreement about this. Fears of further pain to come cannot easily be banished.

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Commodity prices have fallen, on some estimates, by around 20 per cent or more. This is a relief to most people, with the substantial fall in the price of oil providing the most obvious good news as its benefits flow on to stressed households and (by reducing petrol price inflation) central bankers.

US house prices are still falling. Financial institutions have made massive write-downs, but most people believe there are more to come. The extreme weakness of mortgage providers Fannie Mae and Freddie Mac spreads the pain of the US housing market around the globe.

It may surprise some readers to learn that non-US central banks hold bundles of Freddie's and Fannie's mortgages - now, by any standard, greatly devalued. "Too big to fail" applies without qualification to these financial institutions.

In Britain, house prices are weak and the overall economy is suffering from the weakness of “the city” as it digests the effects falling asset prices.

The Japanese economy has remained stubbornly sluggish and its Government has turned to fiscal expansion. An increasingly elderly and declining population is unlikely to respond with excessive enthusiasm.

China held its US-based assets while the US dollar was falling and will have welcomed its turnaround in recent times. China benefits from lower commodity prices and has plenty of new projects to maintain its extraordinary expansion.

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India and Brazil continue to make strong contributions to global growth. Inflation threatens to undermine their contributions, though there is some evidence of slight easing of inflation in the "BRIC" (Brazil, Russia, India and China) nations.

Russia has been preoccupied with its attempts to bring to heel unruly people on its borders. In so doing, it has signalled it is back as a serious source of geopolitical tension.

In an increasingly interdependent world, economic warfare will be far more effective than it was. The bottom line is slower global growth and some amelioration of inflationary pressures.

Australia has suffered a period of gloomy reflection with indicators of household and business confidence falling sharply.

Economists have been widely quoted as effectively saying "the end is nigh". The end of the decade-and-a-half-long boom, that is. CommSec equities economist Savanth Sebastian said recently: "Rumours of the death of the Australian economy are overdone". (We are grateful to David Uren for this quote.)

Uren himself said: "Business has stunned financial markets by reporting a surge of investment in the June quarter and canvassing plans that would lift spending by more than a third in 2008-09 in signs the Australian economy is defying international turbulence.

"The planned increase in spending is the biggest jump in 26 years, and flies in the face of slumping business and consumer confidence."

Australia has a most resilient economy. Its generic tendency is to run too fast, not too slow. No Eurosclerosis here, comrades. The boom defied the Reserve Bank's rather feeble attempts to rein it in while Ian Macfarlane was in charge of monetary policy.

We all thought that current governor Glenn Stevens, known affectionately in privileged circles as "the Enforcer", would bring the economy to heel. "Had done" was the general judgment.

Subsequent to the capital spending surprise, the RBA reported slower growth of credit, but rather faster growth of "money".

Total credit provided to the private sector by financial intermediaries rose by 0.5 per cent over July 2008, following a rise of 0.4 per cent over June. Over the year to July, total credit rose by 11.2 per cent. Credit for housing has slowed to a bit below 10 per cent.

The Sunday Age's front page screamed "House sales tumble as slump bites". It quoted new figures that show a 44 per cent drop in house sales over the year and noted that Victoria's auction clearance rate had fallen below 60 per cent for the first time this year.

Similar figures for other cities are 51 per cent for Sydney, 43 per cent for Brisbane, 33 per cent for Adelaide and 50 per cent for Canberra. Melbourne's reaction reminds Henry of the angst in 1991 when even the trams were touting for business, allowing Henry to declare: "the policy is working".

There will presumably be quiet satisfaction as the board of the Reserve Bank meets today. The policy of restraint is working. To be sure, tightening was too gentle and too slow, but now the long-awaited easing can begin.

The unexpectedly strong business investment intentions data should mean the easing is modest and far from rushed.

During July, both M3 and broad money grew by a relatively strong 2.2 per cent. Over the year to July, broad money grew by 15.7 per cent. Money growth is no longer regarded as a key indicator, but this data will ring a gentle warning bell to some in the Reserve.

And goods and services (CPI) inflation is now predicted to peak at 5 per cent before it begins its predicted decline.

Three powerful reasons to hasten slowly to reduce interest rates.

Henry Thornton

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First published in The Australian on September 02, 2008 and on Henry Thornton's blog.



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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 www.henrythornton.com.

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