Why interest rates are still too high: Kohler

The rate cut of 75 basis points is the right decision. Fifty points definitely would not have been enough after yesterday’s slew of dreadful data; 1% might have looked like panic.

The rate cut of 75 basis points is the right decision. Fifty points definitely would not have been enough after yesterday’s slew of dreadful data; 1% might have looked like panic.

After last month’s 1% rate cut the markets had a little surge of surprise, but since then shares have fallen 11%, the dollar 8.2% – having been as much as 17% lower – and every piece of economic data since has shocked on the downside.

So, that went well…

The new element in the statement from RBA Governor Glenn Stevens is the mention of China: “There have been further signs that China and other parts of the developing world are slowing as well”. It’s the first time slowing growth in China has been used by the central bank as a reason to ease monetary policy and it is an alarming development.

As a result of that, and the “significant weakness” in industrialised countries that Stevens referred to last month, it appears likely that spending and activity will be weaker than expected.

In fact last night a central banker used the word “deflation”. The President of the Dallas Fed, Richard Fisher, told Bloomberg that there would be no growth in the US next year and that inflation had been “vaporised” – that prices are likely to start falling, although “we’re not in a sustained deflationary trend”. That’s alright then.

Last week’s speech by RBA deputy Governor Ric Battellino is looking more and more out of date with each passing hour.

The fact is that the RBA has been caught with its rates up and is hurriedly trying to compose itself. From sternly warning about higher inflation, the authorities have quickly switched to trying to keep everyone’s spirits up.

The official cash rate should not have been 6% today and it should be lower than 5.25% now, and soon will be.

Ironically, monetary policy and fiscal policy are still in conflict – as they have been for five years – but now they have changed places. The RBA had been trying unsuccessfully to slow the economy while the Howard government happily cut taxes and increased spending. The new gang of politicians is just doing what comes naturally – spending the surplus – but this is now good, while interest rates are still too high.

The problem was the rate hikes in February and March, which were undertaken in response to what looked like irresponsible election promises. The RBA directors were still fighting the last war against big spending politicians, instead of looking ahead to the coming war against recession.

Last week Ric Battellino made what some said were telling positive points about the state of household finances, in the light of the “daily barrage of doom and gloom”. It was widely assumed he was preparing us for the possibility of a smaller rate cut this week – maybe none at all.

But as Melbourne Cup Day came and went, no one thought that any more.

Yesterday the daily barrage of doom and gloom outdid itself, and this time it wasn’t the clanking chains of media and bank economist attention-seekers, but actual stats – retail sales, performance of manufacturing index, jobs ads, house prices, inflation gauge – all down; a lot.

This article first appeared in Business Spectator