Australia | Nov 27 2006
By Greg Peel
BIS Shrapnel is Australia’s leading provider of industry research, analysis and forecasting services. Chief economist Frank Gelber released a statement today suggesting the RBA will raise by 25bps in the first half of 2007, but that the big risk is that rates will need to go higher still.
"The problem of high inflation will not go away quickly. The RBA will retain its tightening bias as long as labour constraints generate demand-inflationary pressure. The key question will continue to be how many rate rises will be required before this episode is over," concluded Gelber.
Wages were up 0.8% in the September quarter, compared to consensus forecasts of 1.1%. The annual growth rate eased from 4.1% to 3.8% – the lowest level in 18 months and a number which most economists considered to be “benign” at best.
The economist reaction to this number depended on their previous stance on monetary policy. Those tipping no further rate rise considered the figure supportive of such. Those expecting another rate rise warned of the seasonality of wage data.
BIS Shrapnel has picked up on the latter, and suggests “the latest data from the Australian Bureau of Statistics indicating a moderation in wages growth during the September quarter is badly misleading”. Most of the easing in September can be explained by the timing of this year’s review of Federal Award minimum rates, notes Gelber, which had not occurred in the September quarter. The Award increase will show up, however, in the next round of data.
"A closer analysis of the latest wage data clearly shows the slowdown concentrated at the low skilled end where award minimums are more relevant. Other aspects of the data continue to show wages growth still running at a touch over four per cent.”
Which means that when low-skilled wages are adjusted up in the December quarter, a very different picture will emerge. Says Gelber: "The extent of wage pressures is of critical importance right now.”
Forget bananas – Gelber believes the monetary policy situation is about to “change dramatically”. Wage-driven inflation will force the RBA’s hand. To this end Gelber believes the RBA will have a tougher time controlling inflation in 2007 than many economists suggest. The majority of economists currently believe another rise is very unlikely.
Mortgage rates are now over 8%, and BIS Shrapnel suggests this is a “trigger point” for borrowers. FNArena spoke to Mr Gelber on this issue. The trigger point suggests intended borrowers will now stay away from the housing market in droves, and a cooling effect will ensue. Add the economic slowing effect of the drought, and a fall in petrol prices, and indications could be interpreted that the pressure will come off inflation.
What Gelber is not implying, however, is that higher interest rates will result in a rush of mortgage casualties. On the contrary, BIS Shrapnel believes households will “again prove resilient in the face of interest rate rises”. While interest payments may have increased, surging employment and resultant rising wages, as well as tax cuts, will ensure households can capably balance out the monthly budget.
This increases the likelihood the RBA will have to raise interest rates again, “and by more than just a quarter of a percent”, notes Gelber.
Australia’s labour markets are tighter than they have been for thirty years. Corporate profit growth is strong, and businesses are in the midst of a major expansion in capacity. There is no suggestion that wage pressure can ease in the short term. Indeed, if wages growth pushes towards 4.5% (from 3.8% last quarter), BIS Shrapnel believes there is a risk the economy will experience a “stronger, more persistent period of inflation”. The RBA may need more significant interest rate rises to rein in booming business investment.
(Note: the September quarter capital expenditure data are released on Thursday. Capex is the benchmark for business investment growth.)
Adding to wage cost pressures is falling productivity. If wages are rising, but productivity is also rising, then businesses are not finding an oppressive increase in costs. However, if productivity is stagnant to down, wage costs will directly affect a business’s margins. After averaging 2.5% productivity growth through much of the 1990s, notes BIS Shrapnel, that figure has fallen to 1.5% this decade. At present, the economy is struggling to post “any productivity growth at all” at the moment.