Tuesday 2 February 2010

A tale of two Central Banks – Reserve Bank of Australia vs Bank of England

The Reserve Bank of Australia (RBA) announced today that they were keeping interest rates on hold at 3.75% after raising rates by 0.25% a month for 3 months in a row. According to the Financial Times this surprised most economists.

In my opinion the RBA seem to have timed their increases well. In September of 2009 the Australian Consumer Price Index (CPI) saw a low in this cycle of 1.26% and even though this was the case they started raising rates in October. We have now seen the RBA increase rates by 20% from their lows. It doesn’t seem unreasonable to me for them to take a pause to see what effect this is having given CPI is still only 2.1% and given the inflation target for the RBA is as follows:

“The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations.”

This target was introduced in mid 2003 and since that time the arithmetic average has been 2.7% so to me as a simple Average Joe they seem to be doing a reasonable job.

Now to the contrast which is the Bank of England. They have kept the Official Bank Rate at a record low of 0.5% now since March 2009. The Bank of England also saw the UK Consumer Price Index (CPI) reach a low in this cycle in September of 2009 at a rate of 1.1%. However instead of following the lead of the RBA they have sat on their hands allowing CPI to reach 1.5% in October, 1.9% in November and we now have the CPI at 2.9% (with last month being the largest month on month increase in history) and the Retail Prices Index (RPI) at 2.4%. I can’t see how they can allow this to occur given the Monetary Policy Framework under which they operate includes:

“The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment. The Government's inflation target is announced each year by the Chancellor of the Exchequer in the annual Budget statement.”

I think the Bank of England have now shown their hand and think they can control the inflation genie and allow “just a little bit of inflation”. I’m backing that they don’t raise interest rates this week. I guess only time will tell.

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