Australian Dollar Nears Us, Flagging 24-year High

The Age

Wednesday May 21, 2008

Tim Colebatch, economics editor, Canberra, With Scott Murdoch

THE Australian dollar has edged closer to $US1, a 24-year high, after Reserve Bank minutes revealed that the bank's board seriously debated raising interest rates again at its meeting two weeks ago.

In words received with disbelief and apprehension on the markets, the minutes of the board meeting record that its members challenged the recommendation by the Reserve's staff to keep rates on hold.

Board members argued over whether the cash interest rate of 7.25% - the highest since 1996 - was "sufficiently restrictive to secure lower inflation over time" given the huge gains Australia will reap in 2008-09 from soaring export prices. "Members spent considerable time discussing the case for a further rise in the cash rate," the minutes record.

"But on balance, given the substantial tightening in financial conditions since mid-2007, and the extent of uncertainty surrounding the outlook, the board decided . . . to allow the current setting more time to work.

"However, should demand not slow as expected, or should expectations of high ongoing inflation begin to affect wage and price setting, the outlook, and the stance of policy, would need to be reviewed."

The revelation took the Australian dollar above 96 US cents, its highest since March 1984, and to just under 100 yen.

On the trade weighted index, it climbed to 73.1, almost a 20-year high.

Some economists were sceptical, asking if the board was simply trying to dislodge complacency on interest rates.

Market economists believe rates have peaked; before the meeting, they put the chance of it lifting rates at 5%.

Others saw the board's threat as real.

"We believe the risks still lie with a further turn of the monetary screws at some point over the next few months," said Commonwealth Bank chief economist Michael Blythe.

The minutes report growing signs that the worst of the financial crisis could be over, although money markets globally remain strained. In Sydney yesterday, Treasury secretary Ken Henry expressed similar views, while warning that "we could be living with the adjustment process for some time".

Dr Henry, a member of the Reserve board, used his speech to the Australian Business Economists to attack those arguing that it should relax its target to keep inflation between 2% and 3% on average over the cycle. "The case for having a medium-term inflation target is that it helps to anchor inflation expectations," Dr Henry said. "Without a secure anchor, an increase in the level of consumer prices, for whatever reason, might feed into wage claims, and generate a costly wage-price spiral. We've seen such things before.

"Present macroeconomic circumstances are as testing as anything we've seen since the mid to late-1980s. But frameworks designed to anchor expectations will not be successful if they are set aside the moment they are tested. It is in testing times that they do their work."

Dr Henry also slammed the Coalition for using its Senate numbers to block the National Transport Commission's findings that heavy trucks should pay higher road user charges to pay for the damage they do to the roads. "If this terms of trade boom is going to have a happy ending, we are going to have to do better than this - a lot better," he said. -- With SCOTT MURDOCH

KEY POINTS

? Australian dollar nears $US1, a 24-year record.

? Reserve Bank minutes reveal the bank's board seriously debated raising interest rates at its meeting two weeks ago.