PKT message, Macroeconomic Muddle as Disaster Looms

Pivotal moment for RBA
By Geoff Elliott
June 30, 2003

NINE Australians spent the weekend poring over documents that hold the key to how much Australians will pay on their mortgages.

The material was sent out last week and delivered under the usual tight security. The nine have spent the past few days studying the documents ? essays, charts and tables ? before gathering in Sydney tomorrow morning to make a decision on what to do.

The nine are the members of the Reserve Bank of Australia board ? governor Ian Macfarlane, deputy Glenn Stevens, Treasury's Ken Henry and the private and public sector appointees, Jillian Broadbent, Robert Gerard, Frank Lowy, Donald McGauchie, Warwick McKibbin and Hugh Morgan.

On Wednesday morning at 9.30 AEST their decision, based on the documents compiled by the economists at the RBA and the subsequent meeting tomorrow, will be announced to the financial markets.

It comes at a time when leading commentators, like Morgan Stanley chief economist Stephen Roach, say the global economy has arrived at a "pivotal moment". Mr Roach says the US is on the precipice of a deflationary spiral.

"Like it or not, we are in uncharted waters, both in diagnosing the world's problems as well as in prescribing the remedies," Mr Roach wrote to clients last week. "I never dreamt that I would live to see such profound challenges."

The state of the economy is always at stake when the RBA board meets ? 11 times a year ? to decide the level of interest rates.

But rarely has its decision-making been so loaded, torn between the precarious outlook for the international economy, implying lower interest rates, against an overheated housing market which implies the need for stronger rates.

These opposing forces have led to most leading economists and financial commentators surveyed by The Australian to forecast the RBA will stay its hand when it announces its interest rate settings to the market on Wednesday morning.

But not everyone agreed, highlighting the mixed messages that the RBA itself has dealt with in the recent past.

Westpac chief economist Bill Evans said the RBA would announce a 25 basis point cut on Wednesday because of the RBA's worries over the global outlook. He said another 25 basis point cut would follow in the months ahead.

In making their decision, the RBA board members rely on information publicly available ? it has no secret set of data to assess. This means it's only their experience assessing economic conditions that separates its analysis on the global and domestic economies from the rest of us.

So when seasoned campaigners like Stephen Roach struggle to come to grips with the economic climate, you can bet the RBA board members are too.

"They have to make a judgment about the strength of conflicting forces and if cutting interest rates will rekindle speculation in the housing market," said ANZ chief economist Saul Eslake.

While an overheating housing market worried the RBA last year, Macfarlane's evidence to a parliamentary committee earlier this month indicated the RBA would cut rates anyway, risking reinflating the housing bubble, if the global outlook kept declining.

Since his June 6 appearance the messages from the US economy ? the world's biggest market and the most important one when the RBA considered the international outlook ? have been mixed. And last Wednesday the US Federal Reserve cut its interest rates 25 basis points to just 1 per cent.

It compared with Australia's base rate of 4.75 per cent. Australia's relatively high rates against US interest rates have made Australian dollar bonds more attractive to international investors and are the reason the Aussie dollar spiked 20 per cent higher this year.

This is also weighing on the board since a higher Australian dollar is crimping Australia's exports and blowing out the trade deficit, a sure reason why Ken Henry, the RBA's director representing Treasurer Peter Costello, is sure to continue his argument for an interest rate cut this week.

The Australian revealed earlier this month that Mr Henry argued for a rate cut at the June board meeting, reflecting the Howard Government's concern about the impact of a rising dollar and the effect of the drought.

"Most forecasts give a dismal outlook for exports," said Westpac's Mr Evans. "And GDP growth is running at 3 per cent, which is 1 percentage point below the long-term average of Australia. Cutting rates risks reinflating the housing bubble but the RBA is prepared to take that risk."

But CommSec senior analyst Craig James differs: "The Reserve Bank has not altered official rate settings for 12 months and we expect the streak to extend for yet another month," Mr James said.

"The domestic economy remains firm with unemployment at 13-year lows, consumer confidence at nine-year highs and the construction sector operating at full capacity.

"The Reserve Bank remains worried about the risks posed by the global economy, but these have been dealt with by yet another US rate cut. In the US, stimulus is coming from all directions, boosting recovery prospects."

Mr James has been more bullish this year on the economic outlook than other economists. "I think concerns over deflation in the US are seriously overstated," he said.

But the various views made predictions on which way the RBA would jump impossible, particularly since the RBA itself is likely to be divided on the outlook.

Indeed, the predictions from the RBA itself have been wrong in the past 12 months.

This time last year, Mr Macfarlane flagged the RBA was likely to tighten interest rates by 1.5 percentage points. Now Mr Macfarlane is considering the possibility of cutting them.

Evans says there will be brighter news on the global economy at the end of the year. Others say it will be even longer than that. It means Macfarlane will be tempted to take out some insurance with another rate cut this week or next month.

The Australian