Rates set to stay on hold next week

Reserve Bank deputy governor Ric Battellino spoke at a finance industry function this week and suggested that central banks around the world will not hesitate to start raising rates again at the first hint of inflation.

There is growing nervousness among a number of economists about the risk of inflation emerging once the global economy starts to recover. While the large fiscal stimulus measures and record low interest rates over the last nine months are designed to kick start economies and prevent them from falling into protracted recessions, there is a real risk of going too far.

Some commentators are worried that central banks won’t be able to hike up interest rates fast enough in order to stop inflation getting out of control. The challenge for central banks is to pull the right lever, at just the right time. Picking the bottom of the downturn and starting to reverse the huge cuts to date is a big task.

Mr Battellino said: “With central banks doing unconventional things, it is not surprising that there is considerable debate about the effectiveness and consequences of the various measures. On the one hand, some argue that the measures will be ineffective. On the other side of the debate, others argue that they will eventually result in higher inflation.”

At the end of his speech, he concluded that given there is already considerable awareness about the risks of central banks being too slow , then it’s unlikely that they’ll get it wrong.

The RBA has followed other central banks around the world and aggressively cut interest rates in an effort to protect Australia from the worst of the global financial crisis. Australia’s official cash rate has been slashed by 425 basis points since September last year, with the official cash rate now sitting at just 3 per cent. This represents a 49-year low.

Other news out this week on business activity showed that business investment fell by 8.9 per cent in the first quarter of 2009 which is apparently the largest drop in more than 12 years. Analysts had been expecting a fall of only 6 per cent. As a result of this slump in activity, unemployment is set to worsen in the coming months. Many are predicting it will go as high as 9 per cent by 2010.

With Australia now officially in recession, the RBA is not likely to move on interest rates for another few months until a clearer picture of the economy emerges. The federal government’s stimulus measures are still winding their way through the economy and their full impact remains to be seen.

The Reserve Bank board will meet next week on June 2.

Infochoice.com.au