Interest rates look bound to go much higher after the release of the minutes of the October RBA board meeting yesterday.
The minutes indicated that interest rates were lifted at the board meeting because it might have been "possibly imprudent" not to do so as fears about inflation returned to dominate thinking on the board of the country’s key economic regulator.
So rates were lifted 0.25% to 3.25% to start making sure than inflationary pressures in the economy (which were not crushed by the slowdown) do not threaten to derail the Australian economic recovery.
(And the consumer price inflation figures for September next week will give the market a chance to fret some more about rates.)
The move, and the language in the minutes (which will turn out to be the most important for a year) saw the dollar bounce above 93 US cents on expectations of a series of rate rises from the bank in coming months.
According to the minutes of the September 6 board meeting, the central bank board finally moved because it saw the risks of not lifting rates as starting to outweigh the benefits of leaving the cash rate at the emergency setting of 3%.
In fact the minutes termed as "possibly imprudent" the risks of not lifting rates, quite a telling phrase for such a conservative organisation.
"Overall, members concluded that, while downside risks to the domestic economy could not be ruled out, they had diminished significantly over recent months.
"This meant that the balance of risks was now such that the current very expansionary setting of policy was no longer necessary, and possibly imprudent. The Board therefore decided in favour of raising the cash rate."
And the central reason was the fear that inflation, which remains under control but higher than the RBA had been expected, might be boosted by waiting too long.
The minutes leave the question of future rate rises open ended, hinting however that we should not be surprised to see more.
"On the other hand, members judged that, compared with previous meetings, the risks in waiting had increased. In particular, underlying inflation was still, on the latest data, above the target and, while current forecasts suggested it would fall in the coming year, the expected trough in inflation was significantly higher than earlier thought.
"Keeping interest rates at very low levels for an extended period could therefore threaten the achievement of the inflation target over the medium term.
"More generally, very expansionary policy could result in the build-up of other imbalances in the economy, which would ultimately be detrimental to economic growth."
The bank’s minutes pointed out that "conditions in the domestic economy had for some time been noticeably stronger than had earlier been expected.
"Growth forecasts were tending to be revised up. Measures of both household and business confidence had recovered, household spending had remained relatively resilient, house-building activity was in the process of picking up and the risks of a sharp contraction in business investment had receded noticeably.
"The impact of public-sector spending on infrastructure was starting to become apparent. Absent further setbacks, GDP growth could be close to trend through 2010. Inflation was likely to decline in the near term but probably not fall as far as earlier expected.
"At its previous two meetings, the Board had noted the improvement in the economy and had agreed that, if prospects for the economy continued to strengthen, in due course there would be a need to adopt a less expansionary policy stance.
"The question facing the Board was whether the continued picture of improving conditions and prospects over the past month meant that the point had now been reached where the cash rate should be increased."
"Data on the global economy suggested that prospects for all the major regions of the world were improving, though some more noticeably than others.
"The recovery in the advanced economies was relatively subdued, and was expected to remain so owing to on-going balance sheet adjustments following the past couple of years of financial difficulties.
"The Asian economies, on the other hand, had picked up strongly over the past six months and the outlook was quite positive. Overall, growth in Australia’s major trading partners over the forecast period was expected to be relatively close to trend."
On those comments the bank has confirmed that it is moving back towards a "normal monetary stance" where the cash rate, the key interest rate in the economy, should be set at a more neutral level.
With inflation back in the forefront of thinking, next week’s consumer price Index figures (and producer prices) for the September quarter (and the import and export price indexes due out later this week), will be the next big test for the bank’s view on monetary policy ahead of the board meeting on Melbourne Cup Day, November 3.
It will be the first time in over a year that the quarterly CPI figures will have a meaningful impact on RBA thinking about rates. They have paid them some attention, but the bank has been concentrating on the ’emergency’ conditions in the economy, especially a year ago as demand and activity came close to collapse.
The minutes reveal that there was a case made for sitting pat again for another month at least.
"Members noted that there was still a possibility that the re
