Party-time down under except at the Central Bank

ANALYST'S VIEW

When Glenn Stevens, governor of the Reserve Bank of Australia, flew to London in January, he noticed a "striking difference in confidence one encounters when travelling from the Pacific time zone to the European one.''

Had he ventured onto New York or Washington, the disparity would have been even greater.

While the Federal Reserve is slashing rates to ward off recession and consumer confidence is falling, Stevens has the opposite problem.

He's worried that 11 consecutive increases in the Australian central bank's cash rate "� the latest a quarter- percentage point on February 5 "� won't be enough to cool his country's overheated, inflationary A$1 trillion economy, now in its 17th consecutive year of expansion.

"As Australians recharge their batteries over the summer break, after a long year of coping with an economy operating at full stretch, people in this part of the world are hard at work trying to assess the outlook for the world economy,'' Stevens told his London audience on January 18.

From what one sees in eastern Australia these days, it's not clear the batteries have ever run down.

Crowds throng Circular Quay next to Sydney's harbour, some eating and drinking before heading to the famed Opera House for a lavish production of "Carmen.''

Hundreds of people bump each other on the promenade next to the Yarra River in Melbourne while celebrating the Chinese New Year. The cheap Jetstar flights to Hamilton Island near the Great Barrier Reef are chock-a-block with families already in beach gear.

Ready to party
Everyone seems ready to party, except perhaps homeowners whose variable mortgage rates have gone up in line with the latest increase in the Reserve Bank's cash-rate target. Variable, not fixed-rate, mortgages are the rule here.

The effervescence is the result of a remarkable boom fueled by surging demand for Australian commodity exports.

It has produced the lowest jobless rate in three decades "� 4.3 per cent in December "� high corporate profits, sustained government budget surpluses and a tax cut in each of the past five years.

Unfortunately, it has also generated an underlying inflation rate of 3.8 per cent, the highest in 16 years and well above the central bank's target of 2 per cent to 3 per cent. That's why Stevens is worried.

Over the past four years, the volume of exports such as metals, coal and other items has risen about 20 per cent. At the same time, commodity prices have jumped so much that Australia's export earnings increased more than 50 per cent. A lot of the exports have gone to feed China's expanding appetite for raw materials.

Trade gain
The huge improvement in the country's terms of trade has allowed incomes to increase more than a percentage point faster than production for a decade.

Among the 30 industrial nations in the Organization for Economic Co-operation and Development, only New Zealand and Norway have seen a gain in terms of trade in recent years, according to analysts at ANZ Bank in Melbourne.

On February 5, Stevens announced the Reserve Bank decided to raise its target for the cash rate "� essentially the same overnight lending rate that Fed policy makers have cut by 225 basis points since September "� by a quarter point to 7 per cent. And he suggested in a statement that more increases may be needed.

The financial turmoil that has had a major impact on the US and Europe has had a much smaller effect in Australia, except on stock prices, which have been hammered since the first of the year.

More increases?
The share of production capacity usage is high, there are shortages of skilled labor and, in the short term, "inflation is likely to remain relatively high and will probably rise further,'' Stevens said.

That view was reiterated in the RBA's quarterly Statement on Monetary Policy released today, which said that "the risk of inflation remaining uncomfortably high for some time is considerable.

"Minus a further shift in economic risks to the downside, the monetary policy should be tighter in the period ahead,'' the statement declared.

Many analysts in Sydney and Melbourne took that language to mean more increases are on the way and possibly more quickly than in the past.

Until now, the central bank has almost always changed its cash-rate target only at its meeting in the middle month of each calendar quarter. That's partly been because figures for the consumer price index are released only once every three months, towards end of the first month of a quarter.

In December, though, the Reserve Bank made some changes in its communication policies, including issuance of an explanatory statement when the cash rate wasn't changed and publication of minutes two weeks after each meeting. Minutes had never been made public before.

Why wait?
Now analysts are debating whether Stevens might decide that if more rate increases are needed, why wait until May? Why not break another tradition and do it in March?

Some analysts say the central bank should make the move next month. Others think it should wait until May, and there are those who aren't sure it needs to do anything.

What Stevens may be wishing for is a US slowdown that eases commodity prices and perhaps puts a dent in the boom without forcing the Reserve Bank to anger all those homeowners again.

(John M Berry is a Bloomberg News columnist)