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The Reserve Bank of Australia, defying pleas from industry and many nervous federal government politicians, raised official interest rates on Wednesday to a five-year high in its first credit tightening in 14 months. In an announcement accompanying its daily market operations statement, the bank said its policy-making board had decided at Tuesday's monthly meeting to lift the benchmark official cash rate to 5.75 per cent from 5.5 per cent. This is the bank's first rate rise since March 2005 and is the sixth move in an extended tightening cycle dating all the way back to mid-2002. At 5.75 per cent, the cash rate is now at its highest level since March, 2001. This rate rise is particularly controversial, as it comes when record high oil prices are putting a dent in household budgets and when there is much debate about the trajectory of underlying inflation. The timing, just a week ahead of the budget, is also difficult for the federal government, although the RBA, with its sole focus on inflation, has shown no reluctance to tighten credit ahead of budgets in the past. Industry groups in the past week had pleaded with the RBA not to raise rates, saying increased borrowing costs would only reinforce the already intense cost and competitive pressures on manufacturers. This is an argument which found sympathy among some economists, who said that with the economy growing below its potential, the eastern states housing market still flat, core inflation benign and high petrol prices more of a threat to spending than inflation, the RBA risked tipping the economy into a steep downturn. "The economy is not strong enough for large second round effects [from oil prices] to stick. If the economy were strong enough it would already have happened," said Challenger's head of investment markets strategy, Ron Woods. As well, home owners are more sensitive than they have ever been to higher rates. The RBA noted in March that the ratio of household debt to income has more than doubled to just over 150 per cent in the past decade, while the ratio of interest payments to income has increased from about 6.75 per cent to almost 11 per cent. But other economists have argued that with inflation rising, the labour market tight, spare capacity diminishing, consumer spending and credit growth strengthening again, the world economy buoyant and commodity prices booming, the RBA would have risked having to hit the brakes harder if it hadn't raised rates now. "The case is not about current levels of wage and price pressures, but where they might be headed in an economy operating at high levels of capacity and in a very tight labour market," said National Australia Bank's Alan Oster. "The risk in delaying a rate hike now was that a more severe tightening might be needed later." While the RBA had not raised rates since early last year, it had repeatedly warned that its next move was still more likely to be up than down - based on risks to inflation from strong global growth, rising commodity prices, a tight labour market and an absence of spare capacity in the local economy. The case for the bank acting on its declared bias was seen by the markets as strengthening through March and April as a succession of indicators suggested household activity was recovering from a soft spot last year. As well, business investment has remained very strong and exports were at last showing signs of picking up. But the clincher, according to the rate rise camp, was the release last week of the March quarter consumer price index, which showed the annual headline inflation rate back at the top of the RBA's 2-3 per cent target band and the bank's own measures of core inflation also accelerating. However, others said the bank's underlying measures exaggerated the risks to inflation as they do not fully exclude volatile items such as petrol and fresh food. http://afr.com/articles/2006/05/03/1146335766390.html |
