Double rate rise---RBA's shock plan

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Double rate rise: RBA's shock plan
Author: Tim Colebatch
Date: February 25, 2008
Publication:  The Age

Financial markets have marked down another interest rate rise next month as a virtual certainty, after the Reserve Bank revealed it came close this month to delivering two rate rises at once.

The minutes of the Reserve's board meeting on February 5 show it seriously debated lifting rates by half a percentage point in one hit - adding $100 a month to the cost of servicing the average new mortgage - to send Australians a signal about the seriousness of rising inflation.

In the end, the Reserve board decided on the usual rate rise of 25 basis points, or a quarter of a percentage point.

But the minutes added: "The judgement was finely balanced, and the board would continue to review whether policy was sufficiently restrictive to return inflation to the 2% to 3% target within a reasonable period."

Among the reasons it held back was that "additional tightening could be implemented at the March and/or subsequent meetings as judged necessary".

The Reserve has lifted its cash rate from 5.25% at the start of 2005 to 7% now. Another rise would add $50 a month to the cost of servicing a $250,000 mortgage, on top of rises of almost $400 a month from earlier rate hikes and higher bank margins.

Last week , Reserve assistant governor Malcolm Edey warned that the official inflation rate was likely to rise to 4% in the current quarter. He predicted that even without further interest rate rises, the economy would slow rapidly, with growth excluding the farm and mining sectors falling to 2.5% by December this year and to 2.25% by mid-2009.

Further rate rises would imply an even sharper slowdown, with rising unemployment and business failures.

Markets last week took the Reserve at its word, lifting the odds of another rate rise last Tuesday week to 90%. One bank warning there could be a series of rises ahead, pushing the standard mortgage rate close to 10%.

ABN Amro bank economists Felicity Emmett and Kieran Davies argued the Reserve could deliver another three interest rate rises, unless a financial market meltdown got in the way. They also predicted that banks would lift their interest margins again - putting rates up independently of any action by the Reserve - following big write-offs of bad loans by ANZ and others.

Analysts agreed that the minutes, released under the Reserve's new openness policy, underlined that the bank now saw itself at war with inflation, and it was prepared to impose a lot of pain to get it back under control.

Dr Edey yesterday cited national accounts figures as evidence that wage growth has accelerated to a trend level of more than 5%. But more authoritative figures today will test that view, when the Bureau of Statistics releases its wage price index.

Conflicting evidence on wage growth emerged yesterday. The Melbourne Institute released a survey reporting that hourly wages rose just 2.9% in the year to February, in line with their average since 2000.

But a small business survey for the Australian Chamber of Commerce and Industry reported wage growth at the highest levels in 12 years of the survey.

Australia's interest rates are already the highest in any developed country other than Iceland and New Zealand.