Wednesday, June 17, 2009

The next war?

Costello says it'll be inflation

Former Treasurer Peter Costello has declared inflation to be Australia's "next big challenge" as the Reserve Bank has signaled our economic recovery could be stronger than expected.

Mr Costello said that after Australia pulled out of the present downturn it would have to find a way to deal with "all the liquidity" it had created in the attempt to fight it off.

"After we have bottomed and when we start coming out, then you are going to see inflationary fears taking hold, and around the world and you are going to see interest rates whirring back," he told a packed press conference organised to discuss his decision to leave parliament.

"This is only going to happen after we have bottomed and after we are into the recovery, but it is going to be the next big challenge."

"I always believe that you sow the seeds of the next challenge while you are confronting the present one...

...I think the origins of sub-prime fallout lay in the response to the tech-wreck of 2001 and the terrorist attacks when the United States Federal Reserve pumped liquidity in to the system, tried to stave off recession and build confidence.

"Well in this downturn once again liquidity has been pumped up - quite rightly - and interest rates have been cut aggressively, although too late in my view.

"Managing inflation will be Australia's next big challenge".

The International Monetary Fund identified tax as a key priority after recovery begins in a staff paper released overnight.

It found that while the tax system had not caused the global crisis, built-in biases in favour of debt had exacerbated it. It was particularly critical of the tax treatment of executive remunertation.

The Reserve Bank's board minutes are upbeat, with a lexicographical analysis by Commonwealth Securities finding that only 17 per cent of the statements in it were negative compared to 60 per cent positive.

"There's a quiet confidence in the minutes, with members focused on the recovery in China and convinced it will soon reach record growth," said CommSec economist Savanth Sebastian.

The board minutes note that the rate of economic decline in advanced economies is slowing and that there has been a pick up in production in Japan. By contrast Europe remains in a deepening recession.

The Bank still expects "subdued global growth overall" but says "downside risks have lessened".

At home the Bank is upbeat saying it does not expect business investment to fall "to unusually low levels" and describing Australian exports as "remarkably strong" and credit conditions as "improving".

It believes retail spending grew further in May, in part because of the April and May stimulus payments.

It says recent data give it no reason to revise its view that the Australian economy will soon gradually improve and notes that "if anything, some indicators have been on the stronger side".

The Treasury's executive director in charge of macroeconomics David Gruen adopted a more cautious approach to Australia's outlook in a public address late yesterday saying "celebration would be premature".

"The fall in Australia’s terms of trade that is just now hitting the economy on the back of re-negotiated contract prices for iron ore and coal will strip about 3 per cent from national income in the coming year," he told the Sydney Institute.

"That is about the same magnitude - but in the opposite direction - to the boost to national output from the government’s stimulus measures."

"It is encouraging see the gathering signs that the global financial crisis is abating," Dr Gruen said. "But the global recession, and its Australian counterpart, still have some way to run."