Wednesday, July 25, 2007

Today is inflation day: D-day for Australian interest rates

Australian political operatives will take a greater than usual interest in the inflation figures for the months to June due out this morning.

A low result will effectively remove the threat of a pre-election interest rate hike.

A high result will, in the language of the Reserve Bank, make a rate hike a “live issue” when the Bank’s board meets in two week’s time...

The Bank is edgy about what its Governor sees Australia’s unsustainably high rate of economic growth. Asked last month whether Australia’s present rate of growth in non-farm GDP of around 4.5 per cent was sustainable the Governor Glenn Stevens replied “Not forever, no. The economy’s trend capacity to produce output is probably 3 point something”.

His concern is that will eventually push Australia’s underlying rate of inflation up above the Bank’s target of 2.5 per cent.

He said that the lower than expected inflation result reported in March had bought the Bank “more time”.

Market economists expect a relatively high headline inflation rate this quarter fueled by higher petrol prices and more scarce fruit and vegetables as a result of the drought.

But they expect the more important “underlying” inflation rate excluding volatile prices to remain low, increasing by perhaps as little as 0.5 per cent over the quarter and 2.4 per cent over the year.

Such a result is unlikely to tempt the bank to push rates up.

But if it is much higher than that – the Reserve Bank won’t give an indication of how much higher – the Bank has signaled that it is prepared to act.

It would lift its so-called cash rate by 0.25 per cent on Wednesday August 8, the day after the next board meeting, adding an extra $60 a month to repayments on a $400,000 mortgage.

The move would push up the monthly repayment on such a mortgage to almost $3,000 - $320 more than at the time of the last election fought and won by the Prime Minister John Howard on a promise of “keeping interest rates low.”

It would also lend credence to Labor’s claim that under the Coalition housing affordability has hit an all-time low.

On Thursday Labor’s leader Kevin Rudd will host a national housing affordability summit at Parliament House aimed at drawing attention to the problem.
He has pointed to census data suggesting that last year more than half a million households were having difficulty with their mortgage payments, almost double the number at the start of the decade.

Mortgage repayments now account for 9.5 per cent of all household income - a record high, although some of that is due to the greater proportion of households taking out a mortgage. As recently as March 2000 the proportion was 5.5 per cent.

The Reserve Bank has signaled that the high Australian dollar will not stand in the way of it increasing interest rates should it believe that the inflation outlook gives it a reason to do so. Governor Stevens indicated to a gathering of business economists in Sydney last week that he was relaxed about the climbing dollar, now approaching 89 US cents saying "I don't think it's surprising that we have a high effective exchange rate, given what is going on with relative prices of import and export baskets."

His comments were taken as a signal that the Bank would not hold interest rates down in order to prevent the dollar from climbing higher.