Australia | Jul 27 2006
By Greg Peel
Okay, there is no one left in the market who doesn’t believe the RBA will raise rates by 25bps in August to 6.00%. The question now is: will there be another 25bps this year?
It would be nice to find some consensus amongst economists, but then we’re talking about economists. FN Arena has conducted a straw poll and found that Credit Suisse, ABN Amro, GSJB Were and Macquarie say yes, Merrill Lynch, UBS and ANZ say no, TD Securities says probably, HSBC says unlikely, and Deutsche Bank wants to hear what the RBA says next week.
Helpful? Not really. So let’s look at what they had to say.
“Has your fruit bill actually gone up by 50%?” asks ABN. This is a relevant point. Personally, I haven’t bought any of my beloved bananas for weeks now, and I have been eating a lot more rockmelon which is much cheaper. What ABN is saying is that the CPI may have received a huge kick from a 250% rise in the price of bananas, but it doesn’t take into account the fact that most of us have stopped buying them.
Moreover, the banana thing is a temporary blip – something our Treasurer has been quick to point out. He has also pointed out that the other big effect was petrol prices, and that not all of the increase is being passed on. This is true, but there is evidence (probably more so in the PPI) that this has begun to happen. Anyway, Costello is a politician, so his opinion is not worth a bean.
ABN notes that when the post-cyclone banana crop ripens later in the year, CPI growth will lose a whole 0.5%. More generally, ABN suggests 6.00% will be enough for the moment to put a brake on the economy and on consumer spending.
The jump to an annual CPI of 4% yesterday was headline inflation. Of more importance to the RBA is core inflation. Take out fruit and petrol and the CPI only rose 0.6% yesterday to 3.00% – the top of the RBA range, but not above it. In fact, if you apply the RBA’s “trimmed mean” calculations, inflation is now running at only 2.8%, reports Merrill Lynch.
The theory behind the core inflation measurement is straightforward – we aren’t going to buy ridiculously expensive bananas and we will find ways to spend less than we have to on petrol, particularly if the price heads over $1.50/l. Thus the inflationary effects will actually sort themselves out to some extent in the short term.
Merrills notes that while there is definitely inflation entrenched in the food sector (even fast food prices are going up – heaven forbid) there are still offsets in the likes of manufactured goods and clothing prices. It is easy to understand while clothes prices are falling – that new frock will just have to wait if I have nothing left after my petrol bill.
These sorts of adjustments are what the RBA will keep a close eye on. To respond in a knee-jerk fashion to a CPI is not in the nature of a central bank that has shown far more considered caution than its US counterpart.
A common cry from the No camp is that the May rate hike effects are yet to be fully felt. Okay, there are the budget cuts to consider, but if the RBA hikes next week which everyone expects to happen, the RBA will then want to wait for another period of time to assess the damage.
The problem is, the Yes camp has a very good argument as well, and it concerns wages.
Australia is enjoying a period of historically low unemployment, which is great for all of us with a job, but actually dangerous for an economy. Economies like at least some dole queue, because if new workers and skilled professionals are hard to find, wage pressure begins to exert. If wages go up, that cost has to be passed on to prices immediately on the simple basis that wages pretty much never go down.
(The government’s new wage agreement policy would appear to actually be having a downward effect on wages in at least those cases you read about in the paper, but it is in other areas – mining is a case in point – where the opposite is true).
If the common worker has any sort of bargaining chip in wage negotiation it is the CPI. This latest increase would have secretly brought a big smile to the face of every union boss in the country. It’s no use employers sitting at the table spouting that banana prices will soon come down.
An upward wage spiral is a dangerous thing for inflation measures – it feeds on itself.
This is the major concern of the Yes camp. Add to that many other factors – retail sales to a large extent remain resilient, credit growth is more than resilient, commodity prices continue to increase, capex growth remains strong, and then there are those tax cuts again.
Deutsch Bank appears non-committal in its stance on another rate hike. But its economists make a good point, and one which is very much a factor in discerning Fed policy. The real clue will be not in what the RBA does next week, but in what it says. If the rhetoric is hawkish, then we’ll know.
So until next week.