Tuesday, 8 November 2011

Monetary Policy Works!

Even though it was only 8 days ago that the RBA surprised most in the market with a 25 bp interest rate cut, we can already see some effects of that move.

The Westpac index of consumer sentiment shows that net optimism rose 6.3% after the rate cut and there are now more optimists than pessimists. When consumers are optimistic, they tend to spend a little more and as a result, economic growth, profits and employment are a touch stronger and inflation is also a touch higher than it would other wise be. This is what the RBA wanted and the very early (and preliminary) indications suggest it is what they might be getting.

And this is exactly how any textbook would show it.

Having said all of that, consumer sentiment is a transient indicator driven by more than just a lousy 25 basis point cut in interest rates. Employment, wealth, real wages growth, the performance of the cricket team, who knows what exactly, can all influence sentiment. There is also the tricky yet-to-be-determined issue of whether the knee-jerk return of optimism last weekend when the sentiment survey was carried out flows through to a sustained lift in spending, growth and the like. Certainly global economic and market conditions remain a massive threat to Australia into 2012. Our cricket team is also pretty shaky at the moment although hopefully, we can thump South Africa in the test match starting today.

The rise in sentiment in November could easily be reversed in the next month or two.

Which is why the RBA's work is never finished. If employment growth continues to slow, the world economy remains problematic and credit growth weak, the lift in consumer sentiment we saw today will be reversed in the months ahead. We can be comforted in the knowledge that should this occur, the world best central bank, the RBA, can and will keep cutting interest rates as it does its bit to return the economy to an even keel.

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