FINANCE: Why the RBA didn't raise interest rates

Why did the Reserve Bank leave interest rates alone this week? Finance Editor Tiffany Hutton explains that inflation, exhange rates and natural disasters all helped to stay the Bank's hand.

If you were paying attention in the lead-up to Tuesday’s Reserve Bank board meeting, you would have noticed that all the usual economic commentators were saying the same thing — rates won’t go up. And they didn’t.

So why not? Well, interest rates are the main (slightly blunt) tool that the RBA uses to keep inflation within its target range of 2–3%. If CPI is where the RBA wants it, it will generally leave rates on hold. And CPI for the December 2010 quarter was 2.7%, down from 2.8% in the September quarter. So far so good.

But what about all the other economic ‘stuff’ that’s going on? Shouldn’t that be affecting prices and therefore inflation? Yes .. and no. Let’s start with oil. Conflict and unrest in oil producing countries such as Libya puts pressure on oil prices, which we’ve already seen. As an oil importer, Australia experiences higher petrol prices and transport costs, which are obviously inflationary pressures. But these price rises also act like a tax on growth as consumers spend less on other things, so the effects are more or less balanced out. And the current trend for consumers to spend less and save more also puts downward pressure on prices — no news to anyone in retail.

And what about the Australian dollar? It’s at record highs, despite predictions from a couple of months back that it would hit US$1.02 in March and then beat a retreat. Now there are economists saying it could go as high as US$1.08, and arguments that, really, it’s where it should be (it’s been undervalued since it floated). The high dollar is both a good thing and a bad thing. It’s hard on exporters and tourism; nice for travelers and importers.

Of course, one of the attractions of the Aussie dollar is that our interest rates are already high compared to most of the developed world, so investors like it — put interest rates up, and it could push the dollar up further, which we probably don’t want. Received wisdom has always been that investors avoid ‘risky’ currencies when there’s economic uncertainty and market volatility, and the Aussie dollar has traditionally been perceived as one of those currencies, so we see it fall back whenever things get iffy. But that pattern could be changing, as investors focus more on our commodities strength.

Where next with interest rates? CPI for the March quarter is expected to be up because of recent natural disasters, but this is expected to be temporary — so for the time being, rates are probably going nowhere.


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