Thursday, July 22, 2010

The index is going up - rates might too

Whoever wins the election will inherit an economy growing at well above its sustainable rate, making further interest rate rises inevitable according to the latest Westpac Melbourne Institute leading economic index.

The index purports to predict economic growth three to nine months into the future. It came in at 6.7 per cent in May, down from April's 7.5 per cent but still way in excess of Reserve Bank's view of a sustainable rate, believed to be about 3.25 per cent.

Driving the growth are improving international conditions and near-record minerals prices, but so extreme is the prediction that Westpac's chief economist says he doesn't fully believe it.

"But I have to say, over the years - particularly in the Asian crisis when I dismissed what the index was telling me - it turned out to be right," Bill Evans told the Age.

"I was saying then Australia wouldn't cope, the index said Australia would cope, and we sailed through it"...

Mr Evans agrees growth will be above trend, in his view around 3.5 per cent. The Reserve Bank is forecasting 3.75 per cent next year followed by 4 per cent the year after.

Asked in Sydney on Tuesday whether anything had happened to make him back away from those forecasts Bank Governor Glenn Stevens remained confident.

The forecasts give the Bank little room to move should inflation remain high when the figure is released in six days time, with the proviso that conditions in Europe are not seen to pose a risk. The Bank is waiting on the results of so-called "stress tests" on European banks due Friday.

"We think those tests will be okay and we think inflation will be high," said Mr Evans. "The Bank will really not have much choice but to raise rates."

Adding weight to the Coalition's contention that prices are increasing quickly Mr Evans said Westpac has independently modeled the 90 price categories that will be used to determine the underlying inflation rate and has come up with a rate above the 3 per cent level the Reserve Bank says will cause it concern.

"If that happens and if the economic growth remains strong and unemployment low the Bank will lift rates in August and again in November," said Mr Evans.

Meantime Woolworths has cast doubt on the perception that inflation is out of control releasing a food price index based on the prices in its stores of just 1.1 per cent.

Many of the items on the list have actually fallen in price in the past year including beef, poultry, bananas, oranges and lettuces. In the three months to June groceries and general merchandise fell in price, bringing the overall price change to zero when tobacco is excluded.

The Woolworths results results lend support to the government's contention that economic stimulus should not be withdrawn too quickly.

Comparable sales at Big W stores were down 10.2 per cent over the year to June, a result the retailer says of the withdrawal of stimulus payments. Sales at Dick Smiths stores grew less than 1 per cent in the year to June after surging 8 per cent the previous year.

Published in today's SMH and Age

Leading Index May 2010

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