Boosting inflation – Central banks struggle

The Reserve Bank of Australia (RBA) reduced the official cash rate by 25 basis points to 1.50 per cent in the September quarter.

This decision was widely anticipated and so it had little effect on the share market and the Australian dollar. The Australian dollar actually rose and reached US 77 cents during the September quarter. The low rate of inflation, as reflected in Consumer Price Index, was a major factor in the RBA’s decision. In the June quarter the annual rate of inflation fell to one per cent, well below the RBA’s target of two to three per cent. Despite the official interest rate cut, the big four banks were criticised by some of their customers because they only passed on about half of the 25 basis point rate cut through to their mortgage interest rates. At the same time other customers were pleased when the same banks actually increased their term deposit rates in an attempt to maintain their market share.

Could crude oil production be cut?

The price of crude oil almost reached US$48 in September after the Organisation of Petroleum Exporting Countries (OPEC) surprised investors by indicating that a production cut is necessary to lift prices. OPEC proposed a cut of up to 700,000 barrels a day on the level of oil they produced in August. This potential cut won’t be finalised until the official OPEC meeting in November. Historically, it has proven difficult for OPEC to carry through on its desire to cut production. Countries that are part of OPEC need oil prices to rise and this could be achieved by cutting production.

Japan fails to reach goal of two per cent inflation

The Bank of Japan (BOJ) is struggling to meet the challenge that other central banks have encountered in attempting to revive growth and boost inflation. This is despite the use of quantitative easing and in Japan’s case introducing negative interest rates. Inflation in Japan was negative 0.4 per cent in July, far below the BOJ target of two per cent. The BOJ has therefore announced an innovative approach to reaching its inflation target. The BOJ has decided to buy more short term bonds rather than longer term bonds, this reduces the yield on short term bonds and should encourage banks to lend money to borrowers. This approach should be positive for bank profitability in Japan because banks typically borrow money short term and lend it out over the long term. Insurance companies and pension funds should also benefit because they are buyers of long term bonds, which should have higher yields because the BOJ is reducing purchases of these in favour of targeting short term bonds.