Australia faces a long fight to contain and then cut the current high inflation rate which will probably bump up to around 3.25% in the current quarter and continue at that level into 2008.
And inflation will continue at or just under the 3% mark for most of next year and 2009, according to the latest Quarterly Monetary Policy Statement from the Reserve Bank.
The news sent the Aussie dollar lower amid growing concern about the stability of credit markets. The Australian dollar fell below 90 USc for the first time in several weeks and touched 86.12 USc, down around 2.5c and 3.7 USc from last Friday's close in Sydney of 92.85 USc.
The dollar fell to 90.09 US cents from 90.68 cents before the statement was released late yesterday morning, and continued sliding in the afternoon as Asian markets also fell. The slide continued overnight and the currency is now in its biggest sell-off since August.
The dollar continued its slide overnight, touching 88.48 USc, a fall of around 5% from last Friday's finish in Sydney. The perceived higher risks of investing in Australia, are dominating investor sentiment, at the moment.
The above graph shows where the inflationary pressures are coming from, the sharp rise in the price of non-tradables; things like Government charges, rent, housing costs.
The bottom line from the RBA's statement isn't good for home buyers or others with large loans:
Nor does it make sense of the Federal Government's Go For Growth campaign slogan and its tax cuts, which have been endorsed by the Federal Opposition.
Nor does it make sense of the policy initiatives announced by Mr Howard to favour the housing sector and answer the Opposition's attack on housing affordability.
The last thing we need and the RBA would want to see are tax cuts and subsidies driving up home building, just as house prices are growing at more than 10% a year and the economy is struggling to cope with surging business investment.
A surge in home building and investment would place further strains on an already stretched building and construction sector, with the states also planning to spend more on infrastructure over the next five years.
That in turn means little hope of any relief from the current 11 year highs for interest rates: they could even go higher if the Reserve Bank's worries about the difficulties of bringing inflation under control are realised.
The bank says core inflation will accelerate to 3.25% by next month and remain there until next June: that's above the top of its 2%-3% target range (over time) for core inflation.
The bank also cut its economic growth forecast to 3.75% for the year ending June 30, from 4.25%, because drought has slashed farm output.
That would in turn assume no real change in the rate of growth in non-farm activity, which is the major worry of the bank at the moment.
The effect on Australia's economic growth from the global credit crunch is likely to be "modest", but the bank made it clear there is a long fight ahead to control inflation.
The RBA noted that sentiment in global financial markets "remains fragile,'' suggesting it may not lift rates at its last meeting for the year, as some economists and bank believe it will. The best bet for another rate rise is from February to May next year.
The report had little impact on markets which were more concerned about the continuing concerns about the health of global credit markets, and especially those in the US.
The quarterly report fleshed out the thinking behind last week's rate rise to 6.75% for the RBA's cash rate. The commentary in the report was a bit more pessimistic in tone than last week's statement.
The bank said that higher borrowing costs, the nation's strong currency and slowing global growth may cool inflation to 3% by the end of 2008.
“But it is also possible at this stage of a long economic expansion that inflation will be more difficult to contain, particularly if domestic demand does not moderate,'' it said.
"Aggregate demand has been growing at a pace that has put upward pressure on underlying inflation,''
The bank also noted that conditions in the farming industry have "deteriorated over recent months'' because of the worst drought on record.
It kept its forecast for growth in the non-farm economy unchanged at 3.5% for the 12 months ending June 30, 2008, and the following year. With domestic non-farm activity running above 5% in the June quarter, it means a slowdown. The September quarter's National Accounts are due out at the end of the month.
"The continued strength in demand and activity at this stage of a long expansion has brought the Australian economy to a position where productive capacity is stretched and labor-market conditions are tight.
"Consistent with the strong labor-market conditions, the pace of growth in wages has been firm,'' the central bank said. We will get a better idea of wage pressures with the September quarter's wage price index release and average weekly earnings for the three months to August on Thursday.
The AMP's chief strategist and economist, Dr Shane Oliver, said February remained the most likely date for the next interest rate rise, when the December CPI numbers would be known.
"The pattern from the Reserve has been that it tends to wait for the next set of inflation figures before moving,'' Dr Oliver said today.
"If they are going to go again, they will wait until February. They will wait to see the December quarter inflation releases and go then.''
He said that if wages showed signs of breaking out in this week's stats, then the Bank could move in December. "If we got a 1.5 per cent rise in the quarter, then that wou
