RBA must cut rates – and quickly: Kohler

This week’s arrival of a reality check in the form of new IMF forecasts and an admission from the Finance Minister that we are heading for Government debt greater than $200 billion raises an obvious question: What on earth is the cash rate doing at 3%?

Every other country that is experiencing this recession has its official interest rate closer to, or at, zero.

Australia’s authorities seem to be so intent on intoning the mantra that Australia-is-in-better-shape-than-the-rest-of-the-world that they have decided to fight the recession with one arm – fiscal policy.

Monetary policy is, for the moment, tied behind the national back, with the Reserve Bank sitting on a pause at 3%. This month’s cut of 25 basis points was merely an addition to bank profits – a non-rate cut – as the banks gratefully absorbed it. It had virtually no effect on demand.

As a result there is immense pressure on fiscal policy to do the heavy lifting as the Government prepares the 2009 budget. The starting point deficit is $50 billion for this year and next year and the one after that.

The forward estimates period will produce Government debt of at least $200 billion with no further fiscal stimulus or infrastructure spending. The Prime Minister has already said there will be a third fiscal stimulus package.

This means the debt issuance task is going to be very large and difficult, especially as 2009 drags into 2010. Week after week the Australian Office of Financial Management will be required to raise $1.5 billion or more. It will have to pay higher and higher interest rates to attract investors.

Some of the money can be raised from local super funds, especially the army of DIY fund operators, through new issues of inflation-linked retail bonds. The Treasurer, Wayne Swan, will have to join the line of bedraggled finance ministers along the footpath with upturned hats at their feet.

As a result the Australian dollar will fall. At 70 US cents it looks fundamentally overvalued. International investors will not buy Australian government debt at a yield of 4.7% and an exchange rate of 70¢/70¥, when debt levels are at the point where a negative rating watch is likely, if not an actual downgrading.

The inevitable consequence of all this is that Kevin Rudd faces the nightmarish prospect of having to increase taxes while unemployment is still going up – if not in 2010, then 2011…if he’s still in power that is.

Glenn Stevens and the RBA must come to the party, not to save Rudd from electoral catastrophe, but because Australia’s economic policy is beginning to look dangerously unbalanced.

Yes, it’s true that core inflation is stuck above 4%. But just this once the RBA should chuck out its complicated trimmed means and look at actual, headline inflation – 2.5%, right where it should be.

There is little doubt that the Australian official cash rate will be 2% by year-end.

The RBA should do everyone – and itself – a favour and get it there by 30 June.

This article first appeared on Business Spectator.