RBA has little choice but to lift rates

It is hard to see the Reserve Bank board not raising interest rates by another 0.25 percentage points on February 5, following the latest quarterly inflation figures. Not that there aren’t any arguments for keeping rates steady – indeed there are quite a few on offer. Rarely if ever has the Australian economy and the US economy been heading in such opposing directions, and banks have already lifted rates outside any official rates action.

But despite turmoil on world financial markets, a US economy on the verge of recession and the prospect of a worldwide economic slowdown this year that Australia can’t avoid, incredibly it seems the RBA has no choice but to lift rates. It is bound by its monetary policy remit to a take-no-chances stance on inflation and the rise in inflationary pressures evident in the three months to December takes underlying inflation to its highest level in 17 years.

The Consumer Price Index rose 0.9 per cent in the quarter for a 3 per cent annual headline inflation result – at the very top of the RBA’s target band. But the RBA’s two preferred measures of underlying inflation, taking out temporary volatility, are now well outside the band at 3.6 per cent and 3.8 per cent.

The RBA cannot ignore core inflation readings like this. Even with the prospect that a global slowdown will impact Australia in 2008 and take the heat out of the economy. And the oil price, which helped feed inflation last quarter, has already fallen and is set to drop further. The golden lesson from the 1970s and 80s for today’s central bankers, however, is that once you let inflation take hold it takes years to get it back under control.

If the RBA does not continue to clamp down on inflation there is even the risk of 70s-style stagflation here in Australia – where a world slowdown cuts growth here yet does not bring inflation down. It will have to act to raise rates next month and hope that the economy is strong enough to weather an international downturn with only a mild slowing in growth.

A 0.25 percentage point rise in rates will add around $17 to home loan repayments for every $100,000 borrowed.

Infochoice.com.au