Rate Moves The Right Way

Newcastle Herald

Wednesday September 3, 2008

LEADER

MANAGING interest rates in a climate of mixed economic signals and uncertainty in world financial markets can't be easy.

The Reserve Bank of Australia has eased some pressure on consumers and households by cutting rates for the first time in nearly seven years. The bank has evidently judged that the risk of harm to the economy from depressed demand outweighs the threat from inflation.

Cutting the benchmark rate by 0.25 per centage points to 7 per cent represents, as Prime Minister Kevin Rudd noted, "modest relief" for mortgage holders. Major lenders will pass on the full cut, shaving about $50 a month from the average mortgage of $300,000. Given recent sharp rises in the cost of living, any amount of breathing space will be welcomed.

Wedged between stagnant asset values and rising costs, more and more households have been pushed into marginal financial viability. Bankruptcies and personal administrations have risen, as have repossessions and mortgagee sales. As is common in such circumstances, retailers and business sectors which depend on consumers' disposable income have also been suffering, leading in turn to pressure on jobs and still lower demand.

It was important for the Reserve Bank and the Government to show their willingness to help the consumer sector. But in doing so it has been necessary to keep in mind that other parts of the Australian economy are still apparently thriving. Business investment is at high levels especially in the resource and energy sectors largely due to an expectation that demand from growing overseas economies such as China and India will continue to rise.

Two-speed economy

A two-speed economy in which a depressed consumer sector is at odds with booming export industries is troublesome but manageable.

From now on, however, the Reserve Bank may be expected to watch conditions in the Chinese economy almost as intently as it monitors those in Australia. Chinese growth is slowing and China, in its turn, is concerned about its own huge investment in US securities. The American financial system remains fragile in the wake of the deflating credit bubble and the subprime mortgage crash. Diving asset values have put many US banks in danger and there is some uncertainty about whether the US Government can afford to underwrite as big a portion of the risk as it has promised.

Most of the world's central banks and many national sovereign wealth funds appear to have made the preservation of the US banking and credit system their first priority, fearing the global implications of a catastrophic failure in the world's largest economy. In this huge, largely unseen drama, Australia is a bit player with little control over the course of events.

The Reserve Bank's influence is largely limited to the domestic economy where its actions can still hold powerful sway over interest rates. Its decision to put the welfare of Australian households ahead of its desire to suppress inflation across the board is the right response to an unusual and dangerous set of circumstances.