Australian cash rate on hold, May 2008

Yesterday the Australian’s left their official cash rate unchanged at 7.25%, 100 basis points lower than our cash rate. The rate has been on hold since March, but the overall feeling is that the bias is still towards further tightening – especially with the inflation rate at 4.2%.

However, the evolution of the statement between March, then April, and finally in May has been interesting. Beyond all the fluff involved in each statement one underlying factor has been key for the medium term outlook in the RBA’s mind – the strength of domestic demand. The language associated with with domestic demand has changed significantly over the months, in March:

There is tentative evidence that some moderation in household demand is beginning to occur, with business and consumer sentiment softer recently, and household credit demand slowing somewhat

Then in April:

Information becoming available from the national accounts over the past month confirmed that the Australian economy grew strongly through 2007, driven by rapid growth in domestic spending

And finally in May

In order to reduce inflation over time, growth in aggregate demand needs to be significantly slower than it was in 2007. Evidence is accumulating that this is occurring. Indicators of household spending have recorded subdued outcomes over recent months, and demand for credit by both households and businesses has weakened.

As you can tell – the Bank has viewed domestic demand as softening, which implies to them that medium term inflationary pressures will ease, even given the prevalence of short-term inflationary pressures.

This position mirrors the stance of the RBNZ, which has been saying:

The weaker economy will, over time, ease accumulated pressure on resources and reduce inflation pressure. However, short term inflation is likely to remain persistently high, due in large part to repeated increases in food and energy prices.

If RBA stance is truly similar then we will see the RBA not react to “short-term” inflationary pressures.  However, any persistence in non-tradable inflation (which seems inevitable in both countries given the elevated level of inflation expectations) should, in theory, force them to take a tougher stance.

Lets see if our respective Reserve Banks have what it takes to keep prices down!