Has a non-US rate rise ever been so closely watched? On October 6, the Reserve Bank of Australia raised the interest rate by 25 basis points to 3.25%, thus becoming the first developed nation to start tightening monetary policy since the global financial crisis. In some measure it signals a formal end to the crisis.
The move didn’t go down universally well. Ben Potter, research analyst at IG Markets in Melbourne, calls it “both extraordinary and unnecessary”. In his view the RBA had plenty of time and scope to delay rate increases until after Christmas, and since there were no imbalances in the economy there was no obvious need for an adjustment.
Normalized policies
“We cannot fathom today’s decision, especially considering the global rhetoric from the recent G20 meeting that it’s too early to begin withdrawing stimulus and normalizing rates,” Potter said on the day of the announcement. RBA governor Glenn Stevens argued that since Australia’s economic growth in 2010 looks likely to be close to trend, there was no argument to keep rates at such low levels and it was better to start to normalize policy.
Whatever the pros and cons of the decision, it might trigger a broader trend in capital flows: the revival of the yen carry trade and its equivalents elsewhere in the world, notably the US. Before the crisis, Australia was a classic beneficiary of these trades – while one could borrow at negligible rates in such places as Japan, risk-free bank account deposits in Australia could give you 7%, which, while not the highest in the world, was certainly the highest among relatively low-risk countries. That changed as speculators pulled back funds from late 2007 onwards, and as Australia cut rates, reducing the attraction.
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“The carry trade is getting turned back on again. It will be fed further by the Reserve Bank continuing to raise rates here” |
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If Australia now starts raising rates progressively the distinction between what capital will get you almost risk-free in Australia versus the rest of the world will become all the more acute. It’s not inconceivable that interest rates could be back up to 4% before the US Federal Reserve moves its own rates above 0.25% – a 16-fold better return for an Aussie dollar deposit over a US one. One can already see international capital getting the scent – the Australian dollar has strengthened substantially since the increase. “The carry trade is getting turned back on again,” says Shane Oliver, chief economist at AMP Capital Investors. “I think it has a fair way to go as confidence continues to build in the global recovery but rates remain low in key countries like the US and Japan. It will be fed further by the Reserve Bank continuing to raise rates here whereas the US will be on the sidelines until the middle of next year and Japan’s hike might be more than 18 months away.”
CommSec chief economist Craig James thinks overseas investors will be attracted by Australia’s interest rates and economic performance, but also because of its exposure to China’s industrialization, for which he says “Australia is in the box seat for the next decade”. As it is, the country has fared remarkably well during the crisis, continuing a run of 17 years of economic expansion, with only one quarter of contraction (a 0.6% drop in the fourth quarter of 2008) meaning that it ducked a technical recession.
The rate increase might not have much of an impact on the debt capital markets though: James says that although it “represents an attractive environment for investors” and “issuers shouldn’t have any shortage of buyers”, in the short term equity will probably be cheaper and more attractive.
