Tag Archives: inflation

Why what happens in Washington matters in Canberra

Among the economic indicators Treasurer Scott Morrison needs to keep an eye on, the US labour market should be toward to the top of the list.

As the US Federal Reserve begins to gradually edge up its funds rate, Chair Janet Yellen has indicated the tightness of America’s market for workers will be an important factor in shaping the central bank’s thinking on how quickly to proceed with tightening monetary policy.

The state of the US labour market matters because as it gets tighter, so the bargaining power of workers is likely to increase and wages rise, helping force inflation up.

The higher inflation goes, the more the Federal Reserve will feel compelled to raise interest rates.

This matters for Australia because the higher official US interest rates rise, the greater the downward pressure on the Australian dollar (though this relationship should not be overstated).

As the Australian economy tries to establish sources of growth outside the boom-and-bust resources sector, a lower dollar helps by making exports and locally-made goods and services more competitive.

In the past year, the $A-$US exchange rate has slipped down more than 10 cents to 71.2 cents, a far cry from the above-parity levels reached earlier this decade, when massive mining investment was sucking in huge amounts of capital.

Given that the US unemployment rate has already dipped to 5 per cent, it might come as a surprise that the Federal Reserve has only just begun to increase interest rates.

But behind the headline number, data shows that many of the jobs created in the last few years have been casual or part-time. This suggests that there is considerably more slack in the labour market than a 5 per cent unemployment rate would ordinarily imply.

Recent soft income growth underlines the point. In the year to September, US wages grew by 3.66 per cent, virtually half the long-term average of 6.33 per cent.

This is being reflected in consumer spending – US retail sales grew by a modest 1.7 per cent in the year to November.

The Federal Reserve held off embarking on a tightening cycle until it was confident that the US recovery from the global financial crisis was well-established, so its decision earlier this week to raise interest rates, even by a meagre amount, is seen as a vote of confidence in the world’s largest economy.

As he contemplates the sea of red in the Commonwealth’s financial accounts, Scott Morrison can only hope that this is the case.

Despite his bizarre denialism on the matter, the Federal Government does indeed have a revenue problem. Collapsing commodity prices and soft income and corporate tax collections account for a lot of the deterioration in the Budget position.

And the government’s own forecasts suggest there is not going to be a quick turnaround. Earlier predictions that the economy would expand by 2.75 per cent this year have now been pared back to 2.5 per cent, and next year it is expected to grow by 2.75 per cent rather than 3.25 per cent.

Estimates of business investment, household spending, the terms of trade and private final demand have all been downgraded.

As Reserve Bank of Australia Governor Glenn Stevens observed last month, a rebalancing in the sources of growth is underway, but it is a little rockier than might have been hoped for.

With the economy poised between the drag caused by tumbling resources investment and support coming from a nascent recovery in non-mining activity – particularly services – now would seem a bad time to be adding to the weight on activity by cutting into government spending.

To his credit, Morrison has so far eschewed the sort of bloodletting Joe Hockey pursued in his first Budget.

But the cuts he has outlined – crackdowns on welfare ‘rorts’ and the axing and reduction of bulk billing incentives for pathology and diagnostic imaging services, in particular – make little economic sense.

Both sets of measures, collectively worth more than $2 billion, will mean consumers have less money to spend.

As the country’s experience through the GFC has shown, this is significant. Arguably the most effective measure taken by the Federal Government when the GFC hit in late 2008 was to deposit money directly into the bank accounts of millions.

While much of this money was saved, enough was spent to keep shop tills ticking over, shielding thousands of retail and services sector jobs.

This was especially the case among lower-income households, where a higher proportion of income has to be spent rather than saved.

The bulk of Morrison’s cuts will fall on just such households.

At a time when retailers and service providers are trying to find their feet after several years of lacklustre conditions, this is hardly helpful.

Such unhelpful tinkering by governments all too common.

Economists often lament that government interference prevents an economy’s ‘automatic stabilisers’ (floating currency, swings in tax collections and welfare payments) from working effectively, making a difficult situation far worse.

But it is totally unrealistic to expect governments in such situations to do nothing – after all, they have usually been elected on a platform to ‘do something’.

As Ross Gittens suggests, they could do much worse than to devote their energies into devising a path to surplus that kicks in once a recovery is established, and to work out how to better handle future prosperity.



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RBA locks in 2.5 per cent cash rate – for now

Don’t expect interest rates to go up any time soon but, equally, don’t expect them to go down – that was the clear message from the Reserve Bank today.
In unusually direct language, RBA Governor Glenn Stevens has moved to lay to rest interest rate speculation for the next few months, saying the most prudent course for the central bank to take was likely to be “a period of stability in interest rates”.
That is central bank speak for everyone – those predicting imminent rate rises, and those calling for rate cuts – to take a Bex and calm down.
As mortgage holders ponder the pros and cons of fixing part of their loan, and investors do their credit sums, the Reserve Bank has tried to give some reassurance by flagging official rates are not likely to move for some time yet.
As widely tipped, the RBA has decided to hold the official cash rate at 2.5 per cent this month.
What many may not have anticipated though, was the central bank’s unusual willingness to flag its interest rate intentions.
Following the Reserve Bank Board’s first meeting for 2014, Mr Stevens released a statement that showed the RBA is in no rush to change its policy settings.
“On present indications, the most prudent course is likely to be a period of stability in interest rates,” he said.
The Reserve Bank sees no compelling reasons yet for either a rate increase, or a rate cut.
Unexpectedly strong inflation growth in the December quarter (underlying inflation grew by 0.9 per cent to be up 2.6 per cent from a year earlier), along with the falling exchange rate and increased housing activity, had prompted some to speculate that the RBA would soon have to consider raising the c ash rate.
But while Governor Stevens admitted monetary policy was “accommodative”, interest rates were “very low”, and house prices have surged, there was as no yet sign of a dangerous build up in indebtedness. In fact, household credit growth is moderate.
On inflation, the central bank so far does not seem to be phased by the jump in prices in December, some of which it attributed to importers and retailers quickly passing through to consumers much of the increase in costs caused by the easing exchange rate.
Mr Stevens said that although inflation was stronger than the central bank had predicted when it released its most recent Statement on Monetary Policy late last year, it was “still consistent with the 2 to 3 per cent target over the next two years”.
Those arguing the case for a rate cut have pointed to the nation’s anaemic growth rate (2.3 per cent in the 12 months to the September quarter 2013), a plunge in mining investment and weak labour market (the economy shed almost 32,000 full-time jobs in December and the unemployment rate is expected to rise above its current 5.8 per cent) to show the need for more support for activity.
But to this line of argument, Mr Stevens said monetary policy was “appropriately configured” to foster growth in demand (ie don’t expect them to go any lower).
Of course, the RBA might be considering the possibility (raised by Deloitte Access Economics director Chris Richardson) that commercial banks will lower their lending rates as they secure cheaper sources of funding on international markets. The Governor’s statement gives no hint on this front, except to say that long-term interest rates and risk spreads remain low, and there is adequate funding available through credit and equity markets.
As the economy gropes toward sources of growth to replace the sugar hit from resources investment, conditions are likely to stay rocky and uncertain.
In this shifting economic environment the RBA has moved to provide consumers and investors with one welcome point of consistency, at least for the next few months.

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A good week for the RBA

Every now and then you have a week when things seem to go right – your baby son suddenly begins sleeping soundly and copiously, you get the perfect park at work – twice! – and your bank gets in touch to say it has made a $100 mistake in your favour, and lets you keep it (ok, so that last one never happens, it is just a dream).

The Reserve Bank of Australia has just had such a week.

When the RBA Board sits down tomorrow for its monthly monetary policy meeting, it will see little reason to move the official cash rate.

All the signs are that the economy is behaving in ways that it has anticipated, and that are broadly in keeping with its monetary policy stance.

Low interest rates appear to be working to encourage activity in non-mining parts of the economy, particularly housing, while the dollar is depreciating and worrying price pressures are yet to appear.

Though there was a slip in building approvals last month (down 1.8 per cent), much of this was due to the volatile apartments segment of the market, and annual growth remains a healthy 23.1 per cent.

Of course, holding interest rates at historically low levels for an extended period carries with it risk, and some have started to fret that a bubble in the housing market, particularly in Sydney, is developing.

But the overblown talk of an over-heating property market, never well-founded, looks increasingly silly. Sure, house prices have surged in the major cities – most notably Sydney and Melbourne – but there are at least three good reasons to dismiss talk of a bubble at this stage. Firstly, there are signs that the market in established housing is losing some of its heat and price growth is easing. Secondly, and perhaps most importantly, credit growth remains modest – borrowing for housing grew by 0.5 per cent in each of September and October to be up 5 per cent from a year earlier, which is hardly what could be described as “bubble-like”. Thirdly, the nation’s population is growing at a solid rate of around 1.8 per cent, and the easing dollar makes Australian property an increasingly attractive proposition for foreign investors.

There are also encouraging signs that manufacturers and other businesses are starting to pick up the pace of their investment – a development that is coming none too soon, given the rapid deceleration in mining investment.

Official figures show that in the September quarter, mining companies cut their spending on plant and equipment by 7.1 per cent (while expenditure on buildings and structures increased 5.6 per cent). In the same period, manufacturers spent an extra 3 per cent on plant and equipment, and increased funds for buildings by 1.5 per cent.

Any investment plans should be well supported by healthy balance sheets. The Australian Bureau of Statistics confirmed today that business profits grew almost 4 per cent in the September quarter and are up almost 9 per cent in the past year. In the same period, wages have grown 3.1 per cent.

While GDP figures out on Wednesday are likely to show the economy was just ticking over in the September quarter, evidence that non-mining activity is building should push consideration of more rate cuts further into the background.

Instead, the RBA Board may soon begin to consider the timing of a rate hike.

Though it is unlikely to make such a move tomorrow, the central bank will be heartened by the dollar’s slide in recent days. Governor Glenn Stevens made it clear again last week that he thought its sustained strength against the greenback has been increasingly difficult to justify.

Inflation and wages appear well contained for now, but the longer the cash rate is kept at 2.5 per cent, the greater the risk prices could accelerate, which would in turn increase pressure for wage hikes.

As ever for a central bank, the trick is in the timing. Push up rates too soon or too fast, and the dollar could rebound, but leave them low for too long and potentially destabilising price pressures could accumulate.



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Forget fuel spike – tame underlying inflation means no price fears for RBA

A surge in the cost of fuel (up 7.6 per cent) helped drive  a 1.2 per cent spike in headline inflation in the September quarter.

But if you want a clue to what the Reserve Bank of Australia will make of the Consumer Price Index, focus on the measures of underlying inflation, when the quarterly rise was a more moderate 0.65 per cent.

As a result, underlying inflation is sitting around 2.3 per cent – virtually bang on the RBA’s forecast.

There are a few things for the central bank to keep an eye on.

One is the growth in house prices as the long-awaited recovery in the housing market gathers pace. While slow wages growth may help constrain inflation in real estate, the RBA will be increasingly alert as time goes on to the risk (remote for now) that if interest rates are kept low for too long they could fuel risky borrowing. But this is a problem that is a long way off. Economics conditions are still too soft for there to be talk of a rate rise just yet.

The other main factor is the lower exchange rate, and the effect that has had on push up the cost of imports.

If, as expected,  the US recovery gradually reasserts itself after the debt ceiling madness of recent days, the dollar is likely to slide further.

Overall, there is little in the Consumer Price Index numbers that is unexpected, making a November interest rate move no more or less likely.

The behaviour of inflation has caused little concern for the central bank for some time now.

In its most recent forecasts, released in August, the RBA stuck by the outlook it outlined earlier in the year – underlying inflation to hover around 2.25 per cent (in the lower half of its 2 to 3 per cent target band) through to the middle of next year, and gradually rise to around 2.5 per cent thereafter.

It bases its benign outlook on its belief that all the forces acting on prices – some to force them up, some to force them down – collectively cancel each other out.

One of the big positives for households in recent years has been the strength of the currency, which has made imports (particularly clothes, electronics, cars etc) extraordinarily cheap and affordable.

But the dollar’s fall against the US currency in recent months (notwithstanding burst in dollar strength in the last couple of weeks), has seen this boost to household spending power fade.

So, if this was happening in isolation, the effect would be to force prices up.

But softness in the domestic economy, which has seen both economic activity and wages growth slow, means retailers risk quickly losing customers if they push up their prices too fast.

In the RBA’s judgement, the net effect of these opposing forces (a weaker dollar forcing the cost of imports up while a softening labour market and slower wages growth holds back consumer spending) on inflation will be negligible.


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Record-breaking run on inflation in sight

As it contemplates what has been an extraordinarily white knuckle few weeks for the global economy (courtesy of the insanity of sections of the Republican Party), at least one thing the Reserve Bank of Australia Board is  unlikely to worry about when it meets in a couple of weeks is domestic inflation.

The September quarter Consumer Price Index figures due out on Wednesday are expected to confirm that, whatever else might be going on the economy, it’s not happening in prices.

If they show, as tipped, that underlying inflation increased by around 0.5 per cent for the quarter, it will mean the nation is heading into the fourth consecutive year in which price pressures have been contained within the 2 to 3 per cent target band set by the central bank.

Since mid-2010, annual growth in underlying inflation has not reached any higher than 2.85 per cent, and has remained stuck around 2.4 per cent for more than a year.

Laudable as this result may be, it is not really remarkable.

In the sweep of time since the recession of the late 80s/early 90s and the establishment of an independent central bank, inflation has been largely well behaved – apart from a few quarters following the introduction of the GST in 2001 and the growing pains caused by the resources boom during 2007 and 2008 (see RBA chart below).

Underlying inflation 1993-2013 - RBA

If the RBA is correct in its view that inflation will remain within its target band for at least the next two years, it will mean more than five years of moderate price growth – a record-breaking achievement, exceeding the previous high of four consecutive years from mid-2002 when annual underlying inflation stayed between 2 to 3 per cent.

For a central bank which has as part of its mandate the containment of price pressures, this will be a signal achievement.

It also means that politicians may have to update their rhetoric and ditch the trusty old trope of “household cost of living pressures”.

For all the talk about cost of living pressures, there is little sign of them in the figures.*

* There is an argument to be had about whether the Australian Bureau of Statistics, with its CPI methodology, accurately encapsulates what households spend their money on, but this is a subject for a future post.


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Low inflation gives room for rate cut, but no trigger

The Reserve Bank of Australia has ample room to cut interest rates if needed following evidence that inflation was muted in the June quarter, but an August rate cut remains unlikely.

While the central bank appears in no rush to ease monetary policy from its already very-low 2.75 per cent, confirmation that headline inflation grew by just 0.4 per cent in the June quarter, pushing annual growth down by 0.1 of a percentage point to 2.4 per cent, suggests it could cut the cash rate further without immediately feeding a dangerous build-up in inflation.

But the Reserve Bank is likely to keep a wary eye on underlying price pressures, particularly as the weaker dollar means the cost of imports is set to grow more sharply.

Official figures show underlying inflation grew by 0.6 per cent in the June quarter, holding the annual rate steady at 2.4 per cent – just below the middle of the central bank’s 2 to 3 per cent target band.

The most significant price increases in the quarter were for hospitals and medical services (up 3.4 per cent), tobacco (3 per cent), furniture (4.8 per cent) and rents (1.1 per cent).

These were largely offset by falls in the cost of domestic tourism (down 4 per cent) and cheaper fuel (down 3 per cent).

There is nothing in the result that will surprise the RBA, which has said it expects inflation to remain “consistent with the target” for the foreseeable future.

The central bank is likely to closely monitor the evolution of inflation pressures from overseas following the rapid depreciation of the dollar since April.

This effect is yet to show up consistently in the official inflation numbers.

The average price of tradeable goods and services – which comprise about 40 per cent of the consumer price index – rose by just 0.3 per cent in the June quarter, while average inflation among non-tradeable products was 0.5 per cent, mainly due to the pick up in housing activity.

The extent to which the high dollar and fierce international competition has helped hold inflation down was underlined by figures showing tradeables inflation fell 0.7 per cent in the 12 months to June, compared with a 4.3 per cent rise in non-tradeable prices.

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