Thursday, May 24, 2007

The OECD says the tax cuts in the budget may force our Reserve Bank to push up interest rates. Gosh gee, who would have thought it?

The world’s leading economic research organisation says Australia’s Reserve Bank may have to tighten interest rates to stem inflation flowing from the tight jobs market.

In its half-yearly review of the world economy released overnight in Paris the Organisation for Economic Co-operation and Development said it expected Australia’s economic growth rate to climb from 2.5 per cent last year to 3.25 per cent in 2007 and 2008, a more conservative forecast than the 3.75 per cent predicted for the next financial year in the federal budget.

It said such an increase would bring Australia closer to its economic growth speed limit and would mean “that monetary policy may have to be tightened again to ward off inflationary pressures”...

In an apparent criticism of the tax cuts in the budget it said “a prudent fiscal stance would avoid fuelling demand, with the economy close to full capacity”.

It said that a hike in interest rates might be needed to “curb business investment and consumption by households, whose saving ratio could pick-up somewhat in response to the tax cut”.

The tax cuts and the extra spending in the budget will push an extra $70 billion into the economy over the next four years at a time when Australia is enjoying the world’s biggest commodity-price-driven economic boom.

Since 2001, Australia’s terms-of-trade have climbed 37 per cent. The second biggest rise – experienced by Norway – was 33 per cent, followed by Canada with 13 per cent.

The OECD is predicting a tighter labour market than is the Australian Treasury, projecting an unemployment rate close to its present trend of 4.5 per cent throughout 2008. By contrast the budget predicts an unemployment rate of 5.25 per cent by mid next year.

The OECD said that although price pressures appeared contained, inflation should eventually respond to the tight labor market and the “marked rebound” in some aspects of domestic demand seen since late 2006.

It said that the risks to its forecasts were “evenly balanced”.

In a statement welcoming the OECD report overnight the Treasurer Peter Costello made no reference to its observation that the Reserve Bank might have to push up interest rates, preferring to concentrate on what he called its “positive outlook for the Australian economy” and its endorsement of budget measures as “likely to enhance the economy’s supply potential in the longer term”.

Australia’s Reserve Bank lifted rates in May, August and November last year, and in March caused a flurry of speculation that it was about to do so again by noting that it was reviewing Australia’s inflation outlook month-by-month.

Since then Australia’s inflation and wage growth figures have moderated, creating that impression that the Reserve would not need to move on rates again for the rest of the year.

It has lifted rates four times since the 2004 election fought and won on a promise of “keeping interest rates low.”

The OECD lifted its forecasts for growth in Europe and Japan in the year ahead and cut them somewhat for the United States.