Banks and bananas to blame for savings culture: RBA

Deputy RBA governor Ric Battellino says banks raising mortgage rates above the last official November rate increase have contributed to the current savings culture.

During a speech to investment managers in Sydney, he also highlighted next month’s inflation data as key to future rate decisions.

Taking a retrospective look at the economy over the past year, Battelino says the banks’ response following the November rate rise with “substantially larger increases – around 40 basis points” changed consumer behaviour.

“The size of this increase, and the controversy it created, seemed to have a noticeable impact on household behaviour. Consumer confidence fell, though to levels that were still above average,” he says.

“Coincidentally, there was a renewed step up in financial market volatility, stemming from the widening government debt problems in Europe; this probably also contributed to households becoming less confident,” he says.

Battellino said natural disasters had had the biggest impact on the domestic economy at the start of the year.

“As we moved into the early months of 2011, domestic economic activity was severely disrupted by floods and cyclones. The two main economic impacts were the sharp fall in coal production and the destruction of the Queensland banana crop.

“The former meant that GDP was likely to fall in the March quarter, before recovering in the June and September quarters, while the latter meant that CPI inflation would spike higher over the year ahead due to a sharp, yet temporary, increase in banana prices.”

Domestic concerns shifted to global worries by the middle of the year.

“At the time of the July RBA monetary policy meeting, global economic growth had eased, and the downside risks stemming from the European debt problems looked more significant. In Australia, households remained cautious and the housing market was soft.

“Also, it now appeared that the slow recovery in coal production would mean that earlier GDP forecasts for 2011 would not be met. Nonetheless, the medium-term outlook for the Australian economy remained strong. In these circumstances, the board continued to hold rates steady, noting that the CPI outcome to be published in the next month would provide an update on inflation,” he says.

Decisions about interest rate policy through the remainder of the year, he said, would be a balance of these various forces.

“This challenge remains. In fact, with the recent volatility in financial markets adding to the uncertainty about the economic outlook, it does not look like the challenge will become any easier over the months ahead.”

Battelino summarised the three major trends for the year to date as:

• First, the effects of the mining boom have turned out to be stronger than expected a year ago. The terms of trade are noticeably higher and forecasts for national income and mining investment have been revised up over the year.
• Second, despite this strength in the mining sector, overall economic growth is turning out to be weaker. The forecasts published earlier this month reduced growth in GDP for 2011 to 3¼%, versus 3¾% expected last November.
• Third, inflation outcomes for 2011 are likely to turn out to be higher than thought last November, both in headline and underlying terms. Inflation forecasts for the longer term have risen to be a little above the top end of the target range.