Australia | Oct 17 2007
By Greg Peel
The federal government has just revised its FY08 economic growth forecast from 3.75% to 4.25%. Macquarie economists believe the Treasurer is probably behind the curve, and suggest a growth rate of 5% is possible in calendar 2008. This has significant implications for inflation, as do other prevailing factors, and more than one interest rate rise is looking increasingly likely.
Macquarie notes the Australian economy is on track for 4.5% growth in 2007. The year has been highlighted by only one RBA rate hike, fiscal handouts from the government, and a strong labour market boosting consumption and investment. The economy was set to grow at only 4% in 2008, but that was before some significant developments, Macquarie notes.
The first is the government’s planned $34bn in tax cuts. The Coalition may lose government, but it is unlikely Labor policies are going to look wildly different. There is going to be a big fiscal stimulus from whoever wins. The tax cuts would add 1% to GDP growth.
The second is the extraordinary rise in commodity prices recently. Although there has been a large currency effect, for bulk commodities such as iron ore and coal it’s all about demand. The government is forecasting only a 1.5% improvement in the terms of trade from 2007 to 2008. If Macquarie’s forecast of a 50% iron ore price increase alone proves correct, then the government is being way too conservative.
Last we have the NSW government’s decision to attack the housing affordability issue by slashing $25,000 off residential development levies. Macquarie suggests its hard to quantify exactly what impact this will have, but notes that the federal government’s $14,000 first homeowners grant had a massive impact on home building last year. This, again, will boost growth.
With unemployment at a 33-year low of 4.2%, and inflation pressing the 3% threshold, the economy is “not balanced”, say the economists. The risks are to the upside for both growth and inflation.
So the ball is firmly in the Reserve Bank’s court. If there is not another tightening in 2007, it will mean rates will have been raised only once during a full 15 months of booming economy. Is the RBA also behind the curve? Supposedly a lot will come down to the September quarter CPI reading, which comes out on October 24. If underlying inflation reads 0.9% or more, consensus is we go up. If it’s 0.7% or less, consensus suggests we will probably stay on hold. However, Macquarie believes any failure to tighten in 2007 will simply mean more drastic action in 2008.
The Macquarie economists are tipping 0.9% underlying and 1.1% headline for the September quarter. However, despite raging energy and food prices, they do suggest the risk is actually to the downside. This would be due to introduced government child care and pharmaceutical subsidies, and the fact that petrol prices actually fell in the quarter thanks to the strong currency (but not for long). Food is a different matter altogether. But if the CPI does surprise to the downside, and the RBA lays off, it’s only a matter of time.
Macquarie suggests we could see a total of three hikes in the first half of 2008 just to offset the tax cuts.
Would such rate hikes then start to pull up economic growth? Macquarie notes there’ll be a definite effect on homebuyers, but mining investment, government spending and exports are not interest rate sensitive. The Aussie dollar would surely head “inexorably” towards parity, however.
JP Morgan’s economists are also tipping a November rate rise.
They note Australia’s real GDP growth has been running above potential since 2002, but productivity gains have not kept up. Inflation is running towards the top of the RBA’s 2-3% comfort zone because of underinvestment in skills, infrastructure and new capacity. That’s why unemployment is at record lows and utilisation at record highs.
A tight labour market is a fundamental driver of inflation pressure, notes JPM. But so far, Australian wage growth has been relatively benign. This is put down to older people staying at work, 457 visas, and the Welfare-to-Work scheme, all of which has boosted the labour pool. That pool is becoming more and more shallow however, and the skills shortage remains an issue. It is thus likely wage growth will begin to accelerate, says JPM.
The Australian consumer is in a healthy position, the economists suggest, so companies can pass wage rises straight through – as they can with rising inputs driven by commodity prices. All of this means inflation.
Then there’s food, which at 15.5% has the highest weighting in the headline CPI, and for which prices are simply soaring. Petrol prices will shortly have to rise. Water shortages are causing a flow-through effect of higher electricity and gas charges, while residential rents are also through the roof. The only mitigation will be that from lower import prices due to the rising Aussie, and perhaps from the government crackdown on bank fees and charges.
JP Morgan expects the RBA’s 2-3% inflation comfort zone to be breached soon. Third quarter headline will be 1.0% and fourth quarter 0.9% according to the economists’ forecasts, which would put headline annual at 3.2%.
JP Morgan expects the RBA to tighten by 0.25% in November, and again in February. The only challenge to the forecasts could come from the “de facto” tightening already evident due to tighter credit markets, but it’s unlikely to quell inflation pressure in the end.