For Australia, “the Recession we do not have to have”, is a phrase I used at the start of the year to suggest what could be the case in this second half of 2008. It was not a popular view then, and still isn’t, but it is always important to identify where the risk is, and it is not consensus out-performance by any means. The Reserve Bank of Australia deserves a red card, to perhaps be allowed back on the field next game. As I suggested many months ago, if we do experience a recession in Australia it will largely be because the RBA over cooked interest rates. The recession risk also has to do with the psychological transference of economic belt tightening from the US to Australia due to our high degree of cultural and business linkage.
The Reserve Bank of Australia has only one decision to make!
The RBA’s Choice:
- A strong economy with high inflation.
- A weak economy with high inflation.
Domestic monetary instruments do not drive global events? Not rocket science! Raising interest rates in Australia does nothing to bring down the price of oil on global markets, or to slow the Chinese economy! In other words adjusting monetary policy, has no influence on inflation, because domestic inflation is not a product of the domestic economy!!!
All monetary policy adjustments do in these years of 2008 and 2009 is to impact domestic economic growth and well being. Raising rates is not slowing inflation, but it is most certainly slowing the economy by hitting the mortgage belt hard. We live in a global economy where global markets set prices. Domestic interest rate settings are more and more about the domestic growth path, and less and less about inflation. Now this has not historically been the case, and it may not be the case in the future, but it is the case now. Reserve Bank policy settings have zero impact on domestic inflation, because domestic instruments do not impact the global forces currently driving domestic inflation. So while some argue, even bizarrely applaud the RBA for slowing the economy, thinking that means lower inflation, this will not be the case.
I would go so far as to argue that if current RBA rate settings were around 4.5%, still higher than Europe, the US, or Japan, our level of inflation would be no different!
Our view on Australian interest rates is continued upward pressure from financial markets still yet to experience the worst of the sub-prime and broader CDO markets fall out, but that the Reserve Bank will come to realise in the face of slowing domestic demand due to the loss of wealth from lower equity and home values, and higher oil prices, that further rate hikes are simply unpalatable.
The outlook for Australia then is strong export growth, slowing domestic demand, continued decline in home values spreading to the better suburbs, some stabilisation in equity markets in the next few months, RBA policy unchanged until year end when they may in fact reduce rates, and for the Australian dollar to continue to march higher to parity to the US dollar by year end, and perhaps US$1.08 in 2009.