"Inflation is likely to remain relatively high in the short term, and the consumer price index will be further boosted in coming quarters by the recent rises in global oil prices."
With that statement, the Reserve Bank has signalled that we are in for a period of high inflation, much longer than previously thought, and as a result interest rates will remain at current levels for much longer than previously thought as oil price driven inflation works its way through the system.
The warning was issued in the statement after the RBA yesterday left its cash rate unchanged at 7.25%.
The warning that inflation will rise in coming quarters and won’t ease until oil prices (and other cost inputs, such as food) drop, was very different to what it had been saying after previous meetings.
Then the bank said inflation was expected to remain high before moderating. That moderation is still expected, if the slowdown continues, but it will take much longer to happen.
Just how long a period is uncertain, but it could be well into 2009 before there’s any hint of a rate cut. Anyone thinking of the first half is being optimistic, unless there is a sharp contraction in the economy.
In the meantime if the surge in cost pressures starts producing higher wages or a reversal of the recent slowdown in consumption, rates will rise.
Investors and companies now face growing pressure on margins from the longer than expected period of high inflation and high interest rates.
"As a result of earlier decisions by the Board, additional rises in market interest rates and tougher credit standards for some borrowers, there has been a substantial tightening in financial conditions since the middle of last year.
"Conditions in international financial markets remain difficult, with credit concerns resurfacing in the past month.
"The evidence is that the tightening in financial conditions, in conjunction with other factors including rising fuel costs, is working to restrain demand. Indicators of household spending have recorded subdued outcomes over recent months, and credit expansion to both households and businesses has weakened significantly.
"There have also been some tentative signs of an easing in labour market conditions."
While the bank again warned of the potential difficulties the rise in Australia’s terms of trade (currently occurring) could cause by working in the opposite direction to monetary policy, it also expressed concern about the danger that "rising prices of oil and a range of other commodities are adding to global inflationary risks".
"Given the opposing forces at work, considerable uncertainty remains about the outlook for demand and inflation. On balance, while the inflation outlook remains concerning, the Board’s assessment continues to be that demand growth will be moderate this year.
"The most recent flow of information has given additional support to that assessment. Inflation is likely to remain relatively high in the short term, and the CPI will be further boosted in coming quarters by the recent rises in global oil prices."
"Looking further ahead, inflation in both CPI and underlying terms should decline over time, provided demand continues to evolve as expected."
So that means unemployment will have to rise further, retail spending and home building will have to continue at present recessed levels for much longer and consumer confidence will have to remain hesitant to unconvinced.
We will get an update on the course of retail sales and building approvals later today with May figures from the Australian Bureau of Statistics, and tomorrow we will get the May trade figures which should reveal the first significant boost from the higher coal and iron ore prices that will lift our terms of trade this year.
Australia could go close to reporting a trade surplus for the first time in more than six years.
Employment fell in May for the first time in 18 months, but the bank will want to see more than 19,000 or so jobs lost (May’s figures) and the unemployment rate well above 5% (and remember Prime Minster John Howard said he wanted to see the unemployment with "a three in front of it" in the November 2007 election campaign).
Meanwhile the effects of the RBA’s anti-inflation campaign (plus the added 0.40% from major banks on their mortgages) was seen yesterday in figures from the Housing Industry Association.
It said new homes sales fell 5% in May, which was a sharp down from the 0.1% decline in April.
The HIA said sales of new detached houses dropped 5.3% following a 0.2% fall in April, while multi-unit sales tumbled 4.8%.
HIA Chief Economist, Harley Dale, said in a statement that "New home sales results for 2008 to date confirm a renewed cyclical weakness evident across a range of leading housing indicators, a finding that should surprise nobody given the aggressive tightening in monetary conditions seen over the last 12 months".
Not surprisingly, NSW led the decline, with home sales falling 9.4% in May. Victoria saw a 6.8% drop for the month and Western Australia a 4.9% fall.
South Australian homes sales were down 2.7%, while in Queensland, they were off 2%.
And June saw the first contraction in Australian manufacturing activity in five months according to the latest Australian Industry Group/PricewaterhouseCoopers performance of manufacturing index.
It fell 4.2 index points to 47 points in June, which signifies a contraction.
The number was below the 50 point level, which separates an expansion from a contraction, for the first time since January.
Australian Indust
