Thursday, July 25, 2013

Inflation is too low. Stand by for a pre-election rate cut

A pre-election interest rate cut is just a “coin toss” away after startling new evidence showing inflation heading below the Reserve Bank’s target band.

The Bank board meets in twelve days on Tuesday August 6, at a time when the election campaign could be underway. Its Governor Glenn Stevens has made it clear in the past that election campaigns do not prevent him from adjusting rates as he thinks he should. “If it is clear something needs to be done I do not know what explanation we could offer the Australian public for not doing it regardless of when the election might be due” he said in 2007, shortly before lifting rates during the 2007 campaign.

The consumer price index climbed 2.4 per cent in the year to June. But the bulk of the increase - 1.4 per cent - took place in just one quarter, September 2012, as the carbon tax was introduced and the private health insurance rebate was made less generous.

In subsequent quarters inflation climbed by no more than 0.4 per cent per quarter, equivalent to an annualised rate of just 1.6 per cent - well below the Reserve Bank’s target band of 2 to 3 per cent.

Mr Stevens has already made it clear the Bank “looks through” the price consequences of the carbon tax in setting rates and it is understood to be also prepared to look through the consequence of the last year’s changes to the private health insurance rebate, meaning the inflation rate the Bank targets is now below the bottom of its band.

But an August rate cut is not a done deal. The Bank regards inflation as allowing rather than necessitating a cut. Since the board left the cash rate steady at a half-century low of 2.75 per cent in July most international and local economic indicators have weakened. The only significant exception is housing. On Wednesday China reported the slowest pace of manufacturing growth in 11 months. The weaker economic outlook, particularly the weaker Australian employment outlook, will encourage the Reserve Bank board to move in August...

A further cut of 0.25 points would take most standard variable mortgage rates below 6 per cent for the first time since the economic crisis, slicing a further $46 off the monthly cost of servicing a $300,000 mortgage.

“The decision is a coin toss,” said Commonwealth securities economist Savanth Sebastian. “We are pencilling in a rate cut.”

The data shows the first sign of price rises in the wake of the dramatic slide in the Australian dollar which began in May. Prices subject to international trade climbed 0.3 per cent in the June quarter after sliding 2.8 per cent over the previous six quarters. More encouragingly, the prices shielded from international trade climbed an unusually low 0.5 per cent. The Bank sees this as a sign that wage pressure is easing as job markets weaken.

Treasurer Chris Bowen described inflation as “well contained”. Shadow treasurer Joe Hockey said the figures as ‘‘good’’ but that the carbon tax still made people struggle with the cost of living.

The carbon price is set to fall from its present $24.15 a tonne to the European price, at present $6 a tonne, next July putting further downward pressure on inflation.

Mr Bowen is working on an economic statement expected next week and due before the election is called. It will include updated budget forecasts understood to have wiped $6 billion off government revenues over four years and will outline the cost of the Papua New Guinea asylum seeker deal and measures to fund it.

In The Canberra Times, The Sydney Morning Herald and The Age

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