Risk of inflation, The

risk of inflation, The

Pontikis, Peter

ECONOMIC OUTLOOK …

PETER PONTIKIS SAYS THE RBA HAS MORE TO WORRY ABOUT THAN THE GLOBAL CREDIT CRISIS

ON THE EVE OF THE FEDERAL BUDGET and amid the continuing concerns over the global credit crisis, the Reserve Bank of Australia (RBA) believed that the credit crunch was for the most part not a great problem in Australia.

Believing first and foremost (as stated in its recent monetary policy pronouncements) that the country’s main financial risk was inflation, the RBA raised official rates by 10O basis points between late 2007 and early 2008. Together with the collateral effects of expanding credit margins, this saw businesses and households in Australia take a collective hit of about an extra 1.5 per cent rise in the cost of funds.

This 150-odd basis point jump in Australian corporate yields was designed specifically to restrain the country’s growth prospects. It was a well-intentioned move by the RBA to arrest the recent trend of accelerating inflation.

To date, however, and reflecting the substantial lags in the effect that the rate policy has on growth and then inflation, the latter remains on a worrying trajectory. Indeed, in the most recent (March) quarter data released by the Australian Bureau of Statistics, it reached a 16-year high of 4.2 per cent on both headline and underlying measures (which strip out the effect of food, fuel and government charges). This figure is way above the 2-3 per cent target band that the RBA’s policy is specifically framed against.

It should be emphasised that this high Inflation rate is reflective not only of Australia’s inflation predicament, but also that of the whole region. China’s annualised inflation rate, for instance, is now running at 8 per cent. Singapore and Indonesia’s rates come close behind at a 7 per cent rate of growth in general price levels.

In Australia, the effects of the RBA’s rate rises are ready to bite, with a host of partial economic indicators registering a marked slow-down in activity towards the end of the March quarter.

Retail turnover, for instance, is slowing on an annualised basis – to the point that the most recent monthly readings at the time of publication actually ground to a halt on a nominal basis.

According to the ABS, employment vacancy rates have contracted to their most sluggish in three years.

Combine this with private sector deceleration of credit growth, which is at its lowest rate in two years, and the softest consumer readings in 17 years, and it suggests that at least the first and second quarters of 2008 will be characterised by a marked slowing in overall growth.

Still, we mustn’t lose sight of the fact that this economic slow-down is something that is totally expected by the RBA, and indeed is precisely what was desired to help cool the current heated inflation rate.

That said, and in the words of the RBA’s own research, the lag between rises in interest rates and their impact on real economic activity and inflation are both “long and variable”. What does this mean to the lay observer? The full effect of last and this years’ interest rate rises have yet to crest their negative impact on the momentum of the economy in 2008. That is, the worst of the economy’s current deceleration has yet to be sighted.

Economic theory and experience, however, suggest that some time into the September quarter end (if not a little later) will be when the heaviest of the impacts of the rates rises should have passed through the economy.

Yet the end of the September and beginning of the December quarter are quite a way off. In the meantime we should prepare for a run of belowaverage economic data releases likely reflecting the impact of the RBA’s rates rises leaning against growth and inflationary pressures.

In the case that this expected slowdown into mid/late 2008 does not occur, or is too shallow to restrain inflation, then the RBA will be obliged to be obedient to its mandate to respond by raising rates again. It’s a risk that cannot be ruled out if regional trends are anything to go by.

Peter Pontikis FCPA is the group treasury strategist for Suncorp Bank. The views expressed here represent his analysis and do not purport to represent Suncorp’s views.

Copyright CPA Australia Jun 2008

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