By Malcolm Maiden
The Reserve Bank has just announced a small but significant change of course with its decision to leave the cash rate on hold at 4.75 per cent.
The Reserve is charged with maintaining a stable currency, full employment and the economic prosperity and welfare of the people of Australia. But it aims to honour the obligation by targeting one key indicator: inflation. It has just one currency and one interest rate to work with, and its inclination is to use them to pre-empt inflationary trends, not react to them.
Given that, the recent inflation data should have resulted in the Reserve announcing another rate rise today. The Reserve's zone of tolerance for inflation is two to three per cent, and the consumer price index was 0.9 per cent higher in the June quarter alone, and up 3.6 per cent in a year.
The underlying CPI increase, which the Reserve looks at more closely, was also up 0.9 per cent in the quarter, and while that produced an annual increase of 2.7 per cent, within the central bank's zone of tolerance, in the first half of this calendar year it ran at an annualised 3.5 per cent pace.
A private sector inflation survey by TD Securities doesn't contradict those official numbers. It shows inflation rising by 0.3 per cent in July, and by 3.2 per cent in the year to July, up from 2.9 per cent in the year to June.
The Reserve has not moved in the face of this because it knows that the economy is doing it hard outside the mining sector. Households are in the process of saving more, and spending less, so retailers and other companies that service household demand are hurting.
Exporters are also seeing the price of their product in overseas markets become less competitive as the dollar rises. Of the exporters, only the resources groups are shrugging off the strength of the dollar. They are being more than compensated by record commodity prices, which in a circular way, are the main source of the Australian dollar's strength.
Extra household saving in the economy is feeding into loan demand and housing demand, too - statistics released just before the Reserve's decision was announced showed that home building approvals fell by a greater than expected 3.5 per cent in June, and house prices are down 1.9 per cent in the past year.
It has been clear for several months, however, that high interest rates that aim to contain boom inflation were hurting the non-resources part of the economy.
And until today the Reserve has not shown any real sign of not staying the course and raising rates, regardless if inflation gets above three per cent: its argument in fact has been that with the economy running at close to full capacity, something has to give: room has to be made in the non resources economy if the demand in the resources sector for workers, capital and materials is to be met.
On this scenario the slowdown that high rates is producing in regions not benefiting from the resources boom is the slowdown we have to have.
The news, a relief to the non resources sector, is that for the time being at least, the Reserve is persuaded that the process can be stretched a bit. Rates are still going to have to go higher at some point if the resources boom continues.
For the time being, however, it is satisfied that a 4.75 per cent cash rate is delivering a sufficient "degree of restraint".
And on the strength of that, it might hold rates where they are for a couple more months at least, giving itself time to see whether the debt tensions in Europe and the United States continue to ease after recent breakthrough agreements.
mmaiden@theage.com.au