FYI | Sep 14 2006
Is the next move in Australian interest rates higher still?
As reported earlier, it is FN Arena’s observation that economists in Australia have softened their stance on the local interest rates outlook over the past few weeks. Doubts about the strength of economic growth in the US in combination with lower than expected GDP growth figures in Australia seem to have strengthened the view that inflation is likely to ebb lower as economic activity may well turn out lower than previously forecast.
However, independent economic researcher and business forecaster BIS Shrapnel used its Business Forecasting Conference in Sydney on Thursday to try to convince all attendees that if the above impression is correct, the majority of domestic economists are not.
Australian interest rates have only one way to go and that is up, BIS Shrapnel believes. Investors, be it in the stock market or in Australian property, had better prepare for two more RBA hikes of 25 percentage points each by mid-2007. And that is, according to BIS Shrapnel’s charismatic chief economist Frank Gelber, the positive scenario. If things turn out nasty Australian households and businesses could be looking at another 50 percentage points on top of that – no doubt that would leave a decisive mark on the Australian business landscape.
Historically, Gelber (and BIS Shrapnel) has found himself continuously on the hawkish side of the Australian economist community, only to be proven wrong by an RBA who remained on hold throughout the whole of 2005. Over the past six months however this situation has changed. BIS Shrapnel had penciled in two hikes for 2006 but the RBA has already hiked twice, in May and in August.
Gelber is convinced the central bank will do so again, most likely in November. That would leave the RBA one hike ahead of what BIS Shrapnel had forecast six months ago. And it still won’t be enough he thinks. Expect another move up, probably by mid-2007.
Of course, it is possible that the November hike will prove to be enough to get rid of the nasty inflation devil, that’s why the RBA will wait about six months into 2007 as the central bank will carefully weigh its options and the impact of its actions on economic activity in Australia. After all, steering an economy through controlling interest rates is, and remains, a blunt way of economic policy. In Australia, however, it is the only tool at the central bankers’ disposal.
Gelber’s facial expression and body language, while on centre stage at today’s conference, showed his personal bet is on another rate hike post November.
As it happened his timing could have hardly been better with central bankers in New Zealand taking the market by surprise by issuing a hawkish policy statement on the same day as the International Monetary Fund (IMF) chose to warn of possibly higher than expected inflation in the US.
But aren’t oil prices falling?
The current inflation has not so much to do with oil and even less so with bananas, Gelber explained. It is his view that both factors merely take the general public’s focus away from what is really driving inflation up in Australia: an economy constrained by labour shortages, capacity limits and falling productivity growth.
And the problem of the skilled labour shortage in particular won’t go away unless economic growth falls below 2% annualised GDP growth, he believes, leaving the RBA with no other option than applying the brakes two more times, while hoping that will be enough.
Mind you, even with penciling in two more rate hikes over the next year or so, Gelber/BIS Shrapnel still believe inflation will remain above the RBA’s comfort zone with the economic researcher forecasting inflation figures to remain consistently above 3% throughout 2006 and 2007.
Assisting domestic wage pressures in pushing up inflation in Australia will be rising import prices but above all a cheaper currency. Gelber is not a firm believer in the China has kept inflation low theory. Instead, he believes that a strongly appreciating Australian dollar has had a profound impact on the local inflation figures over the past few years. As he expects the currency to devalue over the next two years, to circa US$0.65, this will again impact local inflation, only this time to the upside.
Gelber thinks that commodity prices, while remaining high from an historical perspective, will come down over the coming years and this will pull down the Australian dollar as well.
The result of all this will be a “substantial economic downturn” by the end of next year.
FN Arena intends to dig deeper into BIS Shrapnel’s forecasts for the next few years. Stay tuned for follow up reports on these themes over the coming week.
Your editor,
Rudi Filapek-Vandyck
(Supported by the Fab “Wage Pressures? Where?” Four: Greg, Chris, Rob and Terry)