RBA walks a tightrope in 2008

Australian borrowers should brace themselves for further rises in interest rates. Despite the February rise of 0.25 percentage points taking variable mortgage rates close to 9 per cent for most, it is clear the Reserve Bank is of a mind to take further action.

But let’s hope that borrowers aren’t asked to pay a heavy price for inflation now and then again when rates action turns out to be overdone and the economy goes into recession.

The problem for the RBA is that rises in interest rates take their time to work through the economy and have their full impact – up to 18 months. While economic growth in Australia is likely to remain strong for most of this year, where we will be in 2009 is major question mark.

If the US turns out to be in recession and inevitably drags the world economy into a slowdown as well, Australia might find itself left with high interest rates when it in fact needs low interest rates to underpin growth.

So, how high to lift rates and then when to start cutting them is now a major challenge facing our central bank, and one that history shows is nigh on impossible to get right. We haven’t seen a situation like this since the late 1980s, when rates went ever upward in the face of intractable inflation only to plunge the economy into the worst recession since the Great Depression.

The economy is much better placed these days to withstand the pressures that brought it down 20 years ago, but risks are high heading through 2008.

For now, it seems we are firmly locked in to rising rates. Given changes in the way the RBA reports its monetary policy deliberations under Governor Glenn Stevens, we now get to see the minutes of the board meetings each month. And this month they make for very sober reading. The RBA board gave serious consideration to raising rates 0.5 percentage points, something it hasn’t found it necessary to do for almost a decade.

Unemployment is low, consumer spending is high despite previous rate rises, and inflation is above its target band. The good news is that labour cost figures out this week show wages growth remains steady at 4.2 per cent a year, consistently now around these levels for some time. So at least there is no wage breakout fuelling inflation. Its consumer spending that’s the problem.

The RBA has already made it plain that rates are likely to have to go up further and this will probably be as soon as March. The next inflation figures out in late April will likely show no let up and May could see another rise as well.

Infochoice.com.au