RBA Gov Says Two More Sluggish Years

Sydney, Sep 9, 2008 (ABN Newswire) - Going on last week's intense focus on the Reserve Bank's rate cut and then the National Accounts for the June quarter, you would have expected the appearance in public by a commenting Reserve Bank Governor would have been a headline grabber yesterday.

But the $US200 billion bailout of Fannie Mae and Freddie Mac overshadowed everything else, with a swoon of euphoria sweeping the markets. 

Shares rose (but so did interest rates) and the American dollar firmed, though commodity prices rose as another hurricane menaced the US southern states.

That was an understandable reaction, but for us here it would pay to read the Governor's opening remarks to the House of Representatives Economics Committee to get an understanding of the task ahead of us: two more years at least of relatively tight economic conditions, interest rates falling slowly, inflation falling slowly and unemployment rising.

In short, there's no quick fix for the Rudd Government which now faces a much tougher electorate and economy. The RBA is aiming at a soft landing for the economy, not something rougher.

Mr Stevens' opening remarks contained a nice summary of his views and his comments in answer to the questioning yesterday; in case no one got the message

"Admittedly, we are probably six months away from seeing clear evidence that inflation has begun to fall, and even then it has to fall quite some distance before it is back to rates consistent with achieving 2-3 per cent on average.

"A somewhat larger fall in inflation overall is required on this occasion than was the case in either 2001 or 1995, which were the comparable previous episodes, since the peak inflation rate this time is higher.

"Rather than trying to achieve that larger fall in inflation by pushing it down more quickly, the Board's strategy is to seek a gradual fall, but over a longer period.

'This carries less risk of a sharp slump in economic activity, though it does require a longer period of restraint on demand.

"On the other hand, this carries the risk that a long period of high inflation could lead to expectations of inflation rising to the point where it becomes both more difficult and more costly to reduce it."

Our currency fell as Governor Stevens hinted at another rate cut in his testimony to the House of Representatives Economics Committee and then rose past 83c again, only to ease back under as traders punted on US rates and the greenback rising on the Fannie and Freddie news.The Aussie weakened overnight to around 81.30c.

Our market was up more than 150 points from Friday's 101 point fall: a big turnaround in sentiment. That was despite more weakness in commodities, though oil bounced back to around $US108 a barrel with another Hurricane eyeing off the US southern states. 

Copper was very weak on Friday, but it rose this morning in Asian trading, as did gold. oil, copper and gold retreated in US trading.

Forex traders are worried about the real message from the rescue: that the US economy and financial system are distinctly unhealthy (as moribund as Europe, the UK and Japan and not better placed).

That the bailout was a last resort event didn't occur to many investors: it will when the bills start arriving.

Bond traders are happy that the US Government has stepped in to remove the great uncertainty from the markets: the terrible possibility that Fannie and Freddie could collapse with a multi-billion dollar bang after the US presidential poll in early November, but before the new President and Congress take power in mid-January.

The move by the US Government overshadowed the appearance by Governor Stevens before the Parliamentary Committee at which he didn't rule out a recession, but indicated he thought the chances were remote; hinted at more rate cuts and defended the rate increases this year saying they were needed because inflation was out of control.

While Mr Stevens said that it will take longer than expected to control inflation, it also meant that domestic demand will remain moderate for longer than normal to do this.

"It is expected that annual CPI inflation will reach a peak in the September quarter of about 5 per cent, and be similar in the December quarter.

"This is higher than expected six months ago. But with international oil prices below their mid-year peaks and signs that the pace of food price increases are abating, it is reasonable to expect that CPI inflation will thereafter start to fall back.

"With demand growth slower, capacity utilisation, while still high, is tending to decline.

"Trends such as this usually dampen underlying price pressures over time, and those effects should start to become apparent during 2009 and continue into 2010.

"A somewhat larger fall in inflation overall is required on this occasion than was the case in either 2001 or 1995, which were the comparable previous episodes, since the peak inflation rate this time is higher.

"Rather than trying to achieve that larger fall in inflation by pushing it down more quickly, the Board's strategy is to seek a gradual fall, but over a longer period.

"This carries less risk of a sharp slump in economic activity, though it does require a longer period of restraint on demand.

"On the other hand, this carries the risk that a long period of high inflation could lead to expectations of inflation rising to the point where it becomes both more difficult and more costly to reduce it."

When asked if there was a risk of recession he replied: there was no evidence to suggest there could be a recession in Australia, although it couldn't be ruled out completely.

"Is there a zero risk of recession? No, it's not zero but the most likely one is the one in the published outlook.

"We're in slow growth-like period ... I don't think it would be honest to deny there are some probabilities of that but the most likely outcome is the one we put out over the last six months."

He ruled out a rate rise (which is important if inflation happens to prove persistent: "I think in the near-term the question will be: Do we hold (rates) here or do we go down a bit more? Unless something quite surprising happens, it seems to be unlikely that we'll be reversing course up again in the near term."

He said the rate rises in February and March "had to be done".

"If you think back ... the likelihood we'd be able to sit through one bad CPI and another and not respond was unlikely."

And that the RBA's rate cut last week from 7.25% to 7%, would not have been possible without the earlier rate rises.

Interestingly Mr Stevens said there was nothing in last week's National Accounts for the June quarter that would force the bank to change its forecasts.

"There was nothing in those figures to cause us to revise significantly the forecasts we published in the August Statement on Monetary Policy," he told the Committee in his opening remarks.

He warned, in a sort of circumspect fashion that unemployment is likely to rise as the economy slows.

Mr Stevens said the rise in the jobless rate will be similar to 2001, when the economy slowed.

"I think, in many respects we could see what's happening is akin to the mid-cycle pause in 2001," he said.

"Unemployment rose a percentage point, mid-cycle to 18 months, that sort of episode is what we're experiencing now," he said.

"We observe the unemployment rates goes up for a little while, while inflation stabilises for a little while - that was the story in 2001.

"It's going to rise a bit in the next year to 18 months."


 

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