RBA Policy Decision: Better Safe than Sorry?

As expected, the RBA decided in its latest monetary policy meeting to keep its interest rates at 4.75%. But given the ongoing concerns on rising commodity prices, did the RBA members make the right decision?

With the way positive economic reports are peppered all over the Australian economy, you would find it hard to believe that the RBA didn’t raise interest rates. Furthermore, according to the central bank, global economic expansion, led by the Asian economies, continues to push inflationary pressures higher.

We’re also witnessing a growing demand for commodities, which is why private investment has picked up in the resources sector. Also, Australia’s trade figures are at their highest levels since the early 1950s, and national income is still sporting healthy growth. Lastly, the impressive labor market was also mentioned, as the RBA noted unusually strong growth in employment.

So why didn’t the RBA hike its cash rates?

Apparently, the RBA believes that recent inflationary pressures are still within target, especially since it has already dropped from its 5% peak in 2008. It sees CPI staying within its 2%-3% target for the next year. Also, the rate of savings relative to income remains high, with the already high interest rates limiting economic activity. And let’s not forget the impact of natural disasters!

In the year ahead, the RBA projects continued growth in the labor market, though at a slower pace. It also expects recovery in production over the next few months, with a slight boost from rebuilding efforts.

According to RBA board member Warwick McKibbin, the RBA’s decision to refrain from hiking rates may come back to haunt it. Remember the U.S. housing market bubble that triggered the global financial crisis in 2008? Well, McKibbin thinks a much bigger bubble (and a much bigger burst) awaits Australia if commodity prices get out of hand. Certainly, that’s a catastrophe the central bank will want to avoid!

Aside from that, McKibbin says that Australia’s recent surge in trade can mostly be attributed to monetary expansion in the U.S. and Europe. Although this may boost Australia’s trade at the moment, the problem lies in the fact that this monetary expansion keeps blowing inflationary pressure into asset bubbles.

Now, I’ve never been one to nitpick, but I’m sure there are some of you out there wondering if the RBA made the right decision. I know markets certainly didn’t look too happy. AUD/USD fell immediately after the announcement was made!

Then again, we have to trust that RBA Governor Glenn Stevens is fully aware of what they’re getting into. After all, he wouldn’t be anointed central bank head if he isn’t capable of steering the Australian economy in the right direction, would he?

At this point, Stevens and his policymaking team thought it best to take the more prudent route, knowing that Australia is recovering from the floods that damaged Queensland, New South Wales, and Victoria a few months ago. For now, they probably decided to brush inflation worries aside and focus on getting the Australian economy safely back on its feet.

Of course it will take some time before their recovery is complete. This is why some economic seers predict that the next rate hike could take place midway through the year at the earliest. But if inflationary pressures persist and start taking their toll on spending and growth in the Land Down Under, the RBA might be forced to tighten even earlier.