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Interest rates slide

The announcement of the September quarter Consumer Price Index brought with it a small wave of hope that official interest rates could now be cut by the Reserve Bank on Melbourne Cup Day.

The reason? Wednesday’s CPI came in at 2% for the year, which means the underlying inflation figure should still be at the "low" end of the 2 to 3% inflation target that the RBA operates to, and there is room to cut the cash rate before Christmas.

I’ve been looking at the numbers and talking with economists since the CPI announcement, and we cannot assume the Reserve Bank will rush to reduce interest rates.

I’m happy to be proved wrong, however, on the balance of probability I now believe the Reserve board is likely to leave interest rates where they are and wait for the December quarter CPI figures, which means the next rate movement would be in February 2013.

Here is my thinking.

The annual CPI of 2% represented a jump from the June quarter’s 1.2%. So, inflation is rising. In the breakdown of the September CPI, electricity rose 15.3%, and ‘gas and other household fuels’ rose 14.2%.

These are extraordinary rises, and I believe the RBA will want at least two quarters of price data on power and gas before deciding where they fit into underlying inflation.

Secondly, we can see rises in cost of living basics such as vegetables (up by more than 10%), housing (4.7%), education (6.1%) and health prices, which increased 7.2% in the year to September. These are direct household cost of living pressures, and the RBA will want to ensure its next move is the right one.

There’s another reason why I think the Reserve will hold interest rates over the holidays and wait for the December CPI: economists themselves have already backed away from predicting a November rate cut. Prior to the CPI announcement, 80% of polled economists predicted a Melbourne Cup Day rate cut. Now it’s 60%.

I know that debt-laden Australians who bought property before the GFC want every rate cut they can get. However, rather than living in hope, it’s better to understand the role of the Reserve Bank: it’s an independent agency charged with issuance of currency, the operation of the financial system, the integrity of the "payments" system and oversight of gold and foreign exchange reserves.

Its broader mission concerns prices, employment and general economic prosperity, which it does by setting the cash rate to meet a medium-term inflation target."

It is setting the cost of money in order to keep Australia’s inflation rate inside the optimal target range of 2-3%.

I believe the Reserve wants a proper view of where some of the cost of living pressures are going, and it will wait until January 23 when the December CPI is released. It could be the most important number we read about in the next 12 months.

Mark Bouris is executive chairman of Yellow Brick Road, a financial services company offering home loans, financial planning, accounting and tax, and insurance.

Story Source: www.smartcompany.com.au This article first appeared on Property Observer.

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