Business 21C - Published by UTS Business

May 2010

Raising interest rates for the sixth time in seven meetings, the Reserve Bank of Australia overlooked nervousness in the international economic arena and clamped down hard on what it sees as a big domestic inflation problem.

Reserve Bank Interest Rate Movements

View the Interactive Chart

The Australian housing market hardly paused for breath through the global financial crisis – with house prices up a hefty 20% over the past twelve months. At the same time inflation almost doubled in the first quarter of 2010, with core inflation rising 3.1% from a year earlier.

Analysts said the decision was taken on a “knife edge”. Although The country’s domestic economy is robust, driven by strong demand for commodities from Asia and China in particular, the global picture is lumpier. Greece is skirting default on its debts, and a sense of panic has started to grip Europe over the potential for contagion through its weaker economies.  In the US< although the recession officially ended in the second quarter of 2009, employment is still not recovering.

But it was the stronger performance of our Asian neighbours, and the worryingly fast clip at which Australian prices are rising, that convinced the Reserve Bank Governors to put the boot in once again. Whether it will be enough to reign in the excesses of what seems like an increasingly imbalanced economy, we’ll just have to wait and see.

Historical Overview: The past eighteen months have been amongst the most turbulent in economic history. The collapse of Lehman Brothers sparked a chain reaction that almost brought the global financial system to collapse. Twelve months later, it looks as if disaster has been averted, but governments across the globe are warning that although the worst may be behind us, they will continue to be vigilant and will continue to boost their economies through government spending.

Australia, it seems has been the only rich economy to escape recession, recording modest growth in the second quarter of 2009, against falls across the developed world. This has partly been because of the swift action taken by the reserve bank in the fastest monetary loosening in the country’s history, dropping rates from 7.25% in August 2008 to just 3% in April this year.

This interactive feature shows that policy journey, providing insight into the thoughts of the monetary policy committee at each decision point.

It starts in December 2007 when Australian domestic confidence was at an all time high. With an annual growth rate of 5%, earnings were the highest since the 1950s; and employment the highest in 30 years.

Much of this was due to China, whose economy was expanding by over 15% per annum.

Storm clouds, however, were gathering in the U.S. where the sub-prime housing market faltered, and financial service companies, had, to date, written down some US$120 billion dollars against bad loans, credit default swaps and other complex financial instruments. Losses into the trillions would be revealed over the following twelve months.

By June 2008, the downturn in the US economy was felt by her trading partners, particularly Japan. Even China’s seemingly indomitable economy started to falter, affecting commodity prices. The RBA lowered its policy rate to 7.00% to accommodate the softening economy.

Oil was selling for 140 U.S. dollars a barrel, and under the presidency of George W. Bush, the US couldn’t take a trick.

On September 15th, 2008, the multi-national US banking giant, Lehman Brothers, filed for Chapter 11 bankruptcy protection. It was the largest bankruptcy filing in U.S. history, and was caused by catastrophic losses on the U.S. sub-prime mortgage market. As a result, financial markets ground to a halt, equity markets plummeted, and credit markets froze.

In the UK, where financial services make up some 45% of the GDP – the impact was particularly devastating. The collapse invoked memories of the 1929 stock market failure and raised the spectre of a global depression.

In October, the Australian Federal Government responded by pumping 10 and a half billion dollars into the economy. It was the first of several ‘stimulus packages’ aimed at preventing the country from sliding into recession. It also announced temporary arrangements to enable guarantees for bank deposits.

In November, Barack Obama won the popular vote to become the 44th President of America. A week later he traveled to the White House to meet with President Bush and discuss passing a stimulus package in a session of Congress. This resulted in a 25 billion dollar bail out the automobile industry.

Despite unprecedented fiscal efforts, to the tune of trillions of dollars, by governments around the world, financial markets remained volatile, and global equity markets tumbled back to 2003 levels.

By December, major industrial economies continued to contract. China’s growth rate fell to 8%, resulting in a lower demand for Australian commodities. Oil was selling for 50 U.S. dollars a barrel.

European financial markets remained unsettled despite the Central Bank setting their policy rate at 3.25 %, the Bank of England at 3 %.

The Australian stimulus package seemed to have some impact as retail spending rose, and housing loan approvals rallied. But the best outcome that could be described was that global economic decline had slowed.

In January this year, Barack Hussein Obama II was inaugurated as President. With the economy as an urgent priority he initially focused on designing a ‘stimulus bill’ intended create 2 and a half million jobs at a cost of between 7 and 800 billion dollars.

In February, the U.S. administration unveiled plans to finance a buyout of what had now become known as “toxic” bank assets for 1 trillion dollars. Another trillion dollars was proposed to secure consumer loans. It also announced a “comprehensive stress test,” of the 19 major banks to determine how much federal aid might be needed in the future.

The Australian Government’s announced its “Nation Building and Jobs Package” – a $42 billion stimulus programme designed to pump cash into the economy through consumer, construction and infrastructure spending designed, it said, to limit job losses.

The IMF predicted a further contraction of global growth by 2% resulting in world growth of just half a percent, tthe weakest since World War II.

By March, the the recorded GDP for G7 nations fell 1.8% (the largest since data has been available), but the Chinese economy rallied marginally, and commodity prices finally stabilised.

Financial assistance packages in the US pushed her deficit to a post war high.

By April, although global economic environment was still exceedingly negative, conditions were improving in Australia. Bank demand for funds from the Reserve Bank were dropping off, and the rapid growth in issuance of guaranteed bank debt indicated a return to confidence.

The Reserve Bank noted that there was considerable economic policy stimulus in place but that it required time to take effect.

In June, tensions eased in the global markets when results from the ‘stress test’ of the banks brought some relief from relentlessly bad news. A number of U.S. banks undertook capital raisings, which were generally oversubscribed.

Retail expenditure in Australia was strong, which many economists attributed to the Government stimulus payments in April and May.

The Australian Federal budget brought down on May 12 increased government spending and projected a significant decline in revenues as a share of GDP. Aggregate debt levels were projected to hit over $300 billion over the next four years.

In July, The US economy was still declining with continued weakness in household consumption despite growth in after-tax income.

The Australian GDP numbers for March were surprisingly strong. Exports rose 2%, and retail spending was 7% higher than in September 2008. But business investment fell by 6%; mixed results in the financial markets saw share prices lose momentum; and the rise in government bond yields faltered.

By August and into September, Prevailing conditions remained sluggish, but for the first time in over a year, global forecasts started to move up. Recovery was strongest in industrial production in China where growth reflected the effects of significant monetary and fiscal stimulus.

US output continued to fall, but housing prices appeared to have bottomed. Conditions remained not so good in the UK with another significant decline in output in the June Quarter.

The Australian economy held out better than expected. Retail spending increased 2%. Housing loan approvals strengthened, and demand contributed to increased prices.

The major consideration affecting monetary policy was the risk of overstaying an accommodating setting in a recovering economy, versus the risk of choking off confidence and demand prematurely. The monetary policy committee kept rates at 3% for the four months in a row, but economists were preparing for a hike in the short-medium term.

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