Rates non-decision won’t help

We didn’t get an interest rate rise yesterday, but somehow it feels like we did. After so many economists and commentators – including yours truly – predicted a rate cut, the RBA’s decision to keep rates on hold at 4.25% will leave many businesses and householders feeling ripped off.

This ripped off feeling won’t pass in a day.

Yesterday I wondered if another rate cut would move the needle of consumer and business confidence in a positive direction. I expect this decision to hold will move the needle and confidence will take a hit, so certain did a rate cut seem. If, as seems to be likely, the banks start increasing mortgage and business lending rates so they can protect their margins from rising funding costs, then the damage to confidence will be ugly.

As commentators, including Christopher Joye, have pointed out there is logic to the RBA’s decision.

Inflation is benign, the economy is growing at or around long-term rates (thanks in no small part to the mining sector), unemployment remains low and stable, and the bank says that conditions overseas are improving.

From a macro point of view at least, there’s a very good reason to keep rates exactly where they are and wait for further developments, good or bad.

But that’s the macro view, not the ground level one that so many Australian small businesses are experiencing.

Retailers, already battling fragile consumer confidence, can expect to come under more pressure. This is not a decision to spur consumer spending.

The property and construction sector, which has contracted for 20 straight months, will take no cheer from this. This is a sector starved for funding – that’s not changing any time soon.

The tourism sector won’t be cheering either. The RBA’s decision sent the Australian dollar above $US1.08, putting even more pressure on international tourist numbers.

The dollar’s rise is also more bad news for the beleaguered manufacturing sector and exporters in general. The RBA might be seeing signs of improvement in the global economy, but with one of the strongest currencies in the world, actually selling stuff overseas has become very difficult.

Not getting a rate cut will be disappointing enough for SMEs, but talk that the banks could increase mortgage rates as soon as this week (ANZ will hold its now fortnightly rates review on Friday) is even worse news.

It’s quite bizarre really. On the one hand we’ve got the RBA telling us things are improving in Europe, albeit slowly. On the other hand we’ve got the banks telling us that their funding costs are rising because the European crisis is having an impact on the international flow of credit.

Can both parties right? Well, yes. There has been better news out of Europe in recent weeks, but funding costs won’t fall until we get a more concrete solution. Again, the RBA appears to have taken a macro view and put less weight on the hard facts of higher funding costs.

As with every RBA rates decision, there are a few things to take into account. Interest rates are a blunt macro policy instrument and as such it’s very hard for the RBA to take into account specific areas of the economy (such as small business) when it comes to making its rates decisions. The central bank also has to take a big picture view of the global economy. It also has plenty of room to cut rates in response to further economic problems.

For example, if the banks do increase business and mortgage rates, and consumer and business confidence takes an inevitable hit, then the RBA can cut.

But SMEs, who would bear the brunt of any further falls in confidence, will have good reason to ask whether the RBA should have put the macro view over the ground level view in the first place.


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