Rates, rhyme and reason

There is a faint and disquieting note of caution in the Reserve Bank's minutes of its last board meeting. The arguments that led to the decision to lift official rates by 25 basis points, the third consecutive increase, were "finely balanced".

The bank also acknowledged that it contemplated leaving rates steady and having a fresh look at economic developments in February.

Given that the arguments against raising rates again were rather broad, somewhat vague and not particularly new, whereas the case for a rise was, as represented in the minutes, clearer and more potent, the apparent level of concern and presumably the depth of the discussion ahead of the decision is somewhat disconcerting.

As was the final sentence of the minutes:

"Members saw this adjustment, together with those in the preceding two meetings, as materially shifting the stance of policy to a less accommodative setting and therefore, as increasing the flexibility available to the board at future meetings."

That last phrase says, in effect, that the increase gives the RBA more flexibility, if necessary, to decrease rates in future. That's an admission of the bank's lack of absolute confidence in its understanding of the outlook that wasn't apparent at its previous board meeting and that wasn't referred to in Glenn Stevens' statement the day the rate was last increased.

The arguments against a rate rise were the potential adverse effects on confidence, continuing uncertainty over the international outlook, given conditions in the major economies, and the high level of the exchange rate. Nothing particularly new there.

The arguments for the increase included the need to lessen the degree of stimulus being provided by official rates, that are still below the RBA's "neutral" settings, the long-run pressures on the economy from the combined demand for housing, infrastructure and resources investment in the years ahead, and the risk of leaving rates too low for too extended a period.

There is no dispute that the domestic economy will end 2009 in a far better state than could have been anticipated at the start of the year, when the end of the world, or at least the global financial system, looked possible and the RBA's approach to official rates reflected those fears.

There is still the possibility of another financial crisis offshore, perhaps a sovereign debt default or two, and the prospect of a weak and faltering recovery in the major economies elsewhere.

The still-fragile state of most of the developed economies will complicate and make risky the necessary actions to remove liquidity and taxpayer support from institutions and economies and start the process of bringing the crisis-inflated public debt burdens under control. The path to global stability and recovery remains tortuous and dangerous.

That has, however, been the case during the RBA's period of rate increases and, if anything, the global condition is more stable now than it was back in October, when it began reversing its earlier rate cuts.

A purely domestic perspective would be that the strength of the housing market, the pressures created by the strength of Asian economies and the flow-on effect of the demand for Australian resources, as well as the looming surge in infrastructure spending, all have the potential to re-ignite inflation and demand a conservative approach to monetary policy – the "for" case is far easier to make than the "against".

That's particularly the case, as the RBA makes it clear in the minutes; the rate rises aren't designed to slow economic growth, per se, but rather to reduce the amount of stimulus provided by rates set in response to a financial and economic crisis.

Thus it is puzzling why the board was, apparently, more concerned about the adverse consequences of a rate rise this month than it was in the preceding months, when the world was a more uncertain place and there were residual worries in this economy about the end of the first wave of the federal government stimulus.

Puzzling and mildly disturbing. The language of the minutes suggests that the rate of rate increases will slow next year – that there won't necessarily be a further rise at the February meeting.

With rates still 350 basis points below their pre-crisis level, and at least 125 basis points above the level the market would consider neutral, if the RBA were truly confident about the outlook there'd be no equivocation about the prospect of further rate rises ahead.

That would tend to suggest that sometime in the past month or two the Reserve Bank, or at least its board, became a little more conscious of the external threats to stability than it had been previously – not sufficiently concerned to sit on its hands until February, but concerned enough to give that option a serious pause for thought and discussion.