Yes the Reserve Bank remains concerned about inflation, and no, interest rates are not going to rise again this year, so long as wages don’t rise and ‘things don’t get out of hand’, to paraphrase the central message from the central bank’s first Monetary Police Statement of the year.
The RBA says it now sees underlying inflation falling to 2.75 per cent, from its earlier forecast of around three per cent, for this year and for 2008.
It says headline inflation, (with volatile food and energy included), will dip below the underlying rate as the year goes on, and then rise back to the underlying rate towards the end of 2007.
For that reason and the bank’s more constrained style of commentary, economists now don’t expect any rate move this year.
But the more bearish do warn that the risks, if any, are on the upside because of elements like the rebound in oil prices at the moment.
They point to the Bank’s own statements that while underlying inflation will be back inside the two to three per cent target band, it will still be at the top and that heightens the risk of a rise past three per cent should inflationary pressures re-emerge.
The bank remains concerned that a tight labour market might reignite inflation through higher wages, but it then goes on to point out that while wages are high, there’s recent evidence they’ve stopped rising.
“With the economy still operating at a high overall level of capacity utilisation, it remains possible that the upward pressure on inflation that was evident for much of last year could re-emerge,” the RBA cautioned.
“Nonetheless, given the currently available information, the board judged that the most likely prospect was that underlying inflation in the medium term would be a little below its recent rate, and in these circumstances decided to hold the cash rate unchanged at its February meeting.”
Falling petrol and banana prices in the second half of last year helped to ease inflation pressures after being the two items that forced prices higher in the first half of 2006 and prompted the three rates rises.
With inflation easing a touch in the December quarter and a general feeling of moderating demand, the Bank left interest rates unchanged last week after its first board meeting of the year.
The RBA expects the headline Consumer Price Index to fall to 1.75 per cent in the June 2007 quarter, before that rebound mentioned before to 2.25 per cent by next December.
Here’s what the bank said on inflation:
“Most measures suggest underlying inflation was around ½ per cent in the December quarter.
“While this may understate the strength of ongoing underlying inflationary pressures, taking the September and December quarters together, it does appear underlying inflation was running at a lower rate in the second half of 2006 than the annualised rate of around 3¼ per cent seen in the first half of the year.
“The Bank’s forecasts assume that oil prices and the exchange rate remain around current levels through to the end of the forecast period (December quarter 2008), and that global growth evolves in line with Consensus forecasts.
“The forecasts envisage non-farm GDP growth of around 3¼ per cent over 2007 and 2008, with total GDP growth likely to be a little higher if climatic conditions result in a recovery in rural sector output.
“These outcomes would be somewhat higher than recent growth outcomes, with the improvement reflecting higher exports of commodities following the substantial investment in new capacity, and a gradual pick-up in the house-building sector.
“Growth in consumer demand is expected to remain moderate and investment is likely to grow a good deal more slowly than the rapid rates seen in recent years.
“Overall, growth is forecast to be more balanced than in recent years, with more growth from exports and less from domestic demand.
“The central forecast is for year-ended underlying inflation – currently around 3 per cent – to fall to 2¾ per cent in 2007 and 2008 (Table 16). With the recent falls in oil prices and the unwinding of the banana price increases, headline CPI inflation is expected to fall below 2 per cent in mid 2007 before rising to be about the same as underlying inflation later in the forecast period.
“These forecasts represent a modest downward revision to the inflation forecasts contained in the previous Statement, reflecting both the evidence that underlying inflationary pressures in the second half of 2006 were somewhat weaker than in the first half, and the likelihood that recent falls in world oil prices will result in some dampening effect on cost pressures and inflation expectations.
“But many of the factors that have pushed up underlying inflation over the past few years persist. Ongoing labour market tightness is likely to keep wage growth at above-average levels. In addition, upstream price pressures appear to remain reasonably strong, and capacity utilisation in the economy has been high and is only expected to ease modestly.
“Hence the reduction in inflation is likely to be only modest, and outcomes are forecast to be in the upper half of the target band over the next few years. Overall, risks to the forecasts appear to be broadly balanced.”
It’s an interesting point, that last one: what the RBA is saying that the risks could come from anywhere, rather than from, say oil prices, or capacity problems and exploding wages.
But you get the feeling reading this that the Bank would like to see inflation a good deal lower but realises it has to be ground out of the system slowly.
There is however good news: even if the drought doesn’t break the bank sees higher economic growth over the next one to two years, without too much upward pressure on inflation: and growth higher than we have seen over the past year.
Now that’s good news in an election year, isn’t it?
