Australia: Hiking Rates… But For What Reason?

The Reserve Bank of Australia (RBA) hiked interest rates on Tuesday, from 3.00% to 3.25%, in what appears to have marked the first act of monetary tightening since the 25 basis point hike by the ECB back in August 2008.

I salute the RBA. Unlike the rest of the global central banking community, it has shown an ability and a willingness to act pre-emptively to tame asset price inflation. Rather than sit idly by and watch house prices soar to bubble levels and deal with the subsequent bust, it has been pro-active, and this prudence should underpin the currency and lay the foundations for sustainable economic recovery.

HOWEVER, the key question is why did the RBA hike? If the RBA acknowledges that higher interest rates will encourage savings and prevent another asset price bubble, and is willing to bite the bullet and sacrifice near-term growth to avoid this fate, then well played indeed. However, if the RBA thinks that the economic slump has passed and growth will accelerate from here, and as such inflation is the larger threat, I fear the worst.

Household debt in Australia is larger than that in the US relative to GDP, and private sector deleveraging has only just begun. If this deleveraging process goes into full swing, the RBA may find that it overestimated Australia’s growth outlook, and move swiftly to reverse the hike, much like the ECB did not so many months ago.