Reserve Bank Minutes Reveal What Is On Its Hawkish Radar

The Age

Wednesday February 20, 2008

Malcolm Maiden

MINUTES of the Reserve Bank board's February 5 meeting propel the central bank even further into inflation hawk territory, but they also contain the first official reference to what could be the final and most serious leg of the global credit crisis.

At the meeting, the board once again weighed the push up on inflation here and the pull in the other direction from America's housing market slump and the debt crisis it has spawned. It decided even more unequivocally than it had before that job number one was to suppress strongly growing local demand by raising interest rates.

A half a percentage point rise was seriously considered and rejected mainly because the economy is still in the process of absorbing rate rises, and because, tellingly, the board is ready to raise rates again soon if this month's "finely balanced" 25 basis points rate increase proves to be lenient.

But the minutes also reveal that the board looked at the possibility of what the boffins call reintermediation - a shift in corporate loan demand away from the dysfunctional securitised debt markets to the banks - causing a credit squeeze.

The minutes record that the board noted that the major banks were stepping up lending to meet the reintermediation demand from companies that were previously relying on securitised debt, and "discussed the possibility that funding and capital constraints on banks might, at some point, result in their restricting lending growth."

That comment underlines the risk in the aggressive course the Reserve is charting, and the ultimate risk the debt crisis poses to global growth.

If the securitised debt market remains in disarray, demand for bank loans will rise steadily, as companies fail to roll securitised lines, and look to banks for a solution. And if demand rises too far too quickly, the banks will be forced to ration credit - and a credit squeeze will loom.

We know now that the threat of a demand-induced, bank-lending squeeze is on the Reserve's radar screen. It will drop its hawkish interest rate rhetoric and shift to an easing stance quickly if it materialises.