Short term interest rates remain unchanged

Asset Check - Daryl Dixon

The Canberra Times, 7 February 2010


Financial markets were caught out last Tuesday by the Reserve Bank's unexpected decision to leave short term interest rates unchanged. Economists were expecting a 0.25 per cent a year rate rise to deal with continuing inflationary pressures and assist the RBA's stated desire to increase rates to more normal levels.

Following on the three earlier 0.25 per cent increases, delaying a further increase in a relatively neutral decision given the time delays necessary for these increases to have their desired impact.

The explanation could be as simple as the RBA's board not wishing to be seen as blindly following market expectations but there are other issues possibly affecting the decision.

The disturbing issue behind the scenes for financial markets is whether the RBA has information that the economic situation overseas and is Australia about to deteriorate. Even without such specific information, there is already concern about the global impact of the recent Chinese measures to dampen down credit growth.

This concern has unsettled share and commodity prices directly resulting in a fall in the Australian dollar. The RBA has now contributed to further weakness in the support for our dollar by creating uncertainty about future interest rate increases. This could well be part of a conscious plan to help the Australian economy and exporters through a lower currency exchange rate.

Financial markets are also worried about the potential damage from the latest development in the carriage trade. This practice of borrowing in low interest rate countries to invest in higher rate economies could play a crucial role in determining the future state of the economy and investment in Australia. At the Davos conference last week, it was revealed that over $US1.5 trillion ($A1.7 trillion) has been borrowed for short terms at low interest rates for investment in emerging countries and high interest paying destinations such as Australia. 

The unwinding of the earlier largely Japanese funded carriage trade was a major contributor to the global financial crisis. With interest rates remaining at historically low levels in the US, the impact of a similar reversal of the short term US dollar based borrowings could be even more serious.

By creating uncertainty about both future movements of interest rates and the value of the Australian dollar, the RBA may be hoping to reduce the potential future adverse impact of the carriage trade on our economy.

Daryl Dixon is executive chairman of Dixon Advisory and Superannuation Services.