Why Stevens is playing with fire

Without policy reform the Reserve's cut may cause inflation, and damage banks and housing rather than boosting business activity. But both parties are sitting on their hands.

Reserve Bank Governor Glenn Stevens is playing an interest rate game that is not working and could easily backfire on Australia.

If Stevens is not very careful he will rekindle inflation, damage Australian banks and over-inflate the Australian housing market. He desperately needs the politicians to help him but so far neither side is responding in official policy.

In the textbooks, if you lower interest rates and the currency there will be a surge in business investment and employment will rise. That can’t happen in Australia because the politicians have made investment too dangerous and the long period of high currency has embedded imports into just about every part of the society. That is not about to change.

The consumer price index rise in the last three quarters is around 1.3 per cent – way below target – but the 15 per cent fall in the Australian dollar since mid-April is only now starting to kick in. In my view we are going to see a volley of price rises, particularly if the currency falls further.

The first sign of this was buried in this week’s Dun and Bradstreet business outlook report, which showed that in the June quarter actual price rises were more than double the average rate of the previous four quarters. You have to go back to the December 2011 quarter to find a higher rate of price increases. Price rise expectations in the survey are benign but actions are not.

The Australian dollar got some respite after the interest rates reduction because many in the market had expected a half a per cent rate cut.

But the Australian dollar is likely to fall further when the US starts cut back on quantitative easing.

What Stevens is actually doing is forcing more of Australian savings into bank shares to get income, which will force banks to distribute unsustainable amounts of their profits. This is a subject I will return to. The other avenue for people with savings is to buy houses because this is the one area where there is almost unlimited credit. As with bank shares, we are in danger of pushing up values to levels that may not be sustainable.

What we need is for low interest rates to kindle non-resource business investment but on this front Stevens’ lower interest rate policy has been a complete failure. On their own, further rate cuts will be just as useless in breaking the strike of capital in non-mining Australia. 

The politicians have to change the rules. Kevin Rudd has no plan to change the rules so if he wins the election while there will be a surge of routine catch up investment after the poll the outlook will remain grim.

Tony Abbott does plan to change the rules dramatically for small and medium business (large enterprises will have to change their management practices to participate) and his policies have been revealed to Business Spectator (Abbott’s red-letter day for enterprise, August 1).

But where are the announcements? There is absolute silence and all we hear about is carbon tax (Virgin's carbon collision course, August 6).

While Business Spectator has a wide audience it is not sufficient to brief only Business Spectator readers – you must tell the voters and the business community.

Kevin Rudd believes that Abbott is a policy lightweight and that Abbott is all hot air. While the campaign has only just started, to date Rudd is right. Unless the rules are changed Stevens’ interest actions will be counterproductive.