Monday, November 12, 2007

Showdown at high noon: Reserve Bank to take aim at the Government today

The Reserve Bank has embarked on a collision course with the Coalition's reelection campaign. It is is set to undermine one of its key campaign pledges just an hour before the Prime Minister strides to the podium to deliver this campaign launch speech today in Brisbane.

The Bank's Quarterly Statement on Monetary Policy – to be released at 11.30am – will include detailed forecasts which will indicate whether or not it plans to hike interest rates again at its next meeting in December.

Never before has a Quarterly Statement from the Reserve Bank been so keenly anticipated.

The Bank in believed to have seriously considered back-to-back rate hikes the last time it hiked interest rates in August...

...only deciding against an immediate follow-up in September after the US credit market crisis intervened.

If, as then, the Reserve Bank's detailed forecasts in the Quarterly Statement indicate that inflation will remain stuck at the top of its target band for the rest of financial year it is likely to hike rates again in December without waiting for further inflation figures.

The Bank last hiked rates back-to-back in November and December 2003.

Late Friday the futures market was pricing in 25 per cent likelihood of a back-to-back hike in December. At one point earlier in the week it had been pricing in a 41 per cent chance.

Tough words from the Bank today accompanied by strong inflation forecasts will sharply lift that forecast.

TD Securities, which conducts its own independent survey of inflation is expecting the Bank to lift its inflation forecasts to 3.0 per cent for December 2007 (the top of its target band) and 3.25 per cent for June (beyond the top).

Westpac's Chief Economist Bill Evans said yesterday that if the forecasts in the last Quarterly Statement in August were a “wake-up call” to the market, the forecasts in Monday's Statement should be “positively shattering”.

“It will be difficult for the Bank to provide much soothing evidence that inflation pressures will subside without contradicting the Governor’s Statement of Wednesday last week that there are, quote: few signs as yet of that strength diminishing,” he said.

“To see the Bank providing a one-year forecast where underlying inflation is above the 2 to 3 per cent band will be a jolt for those expecting a benign interest rate environment.”

A further interest rate hike in December, on top of the two in August and November would lift the standard bank variable mortgage rate to 8.82 per cent. A couple on a $400,000 mortgage would be handing over $200 more in monthly mortgage payments than at the start of the year.

The Treasurer last week said that inflation was under control and the Prime Minister rejected the proposition that a further rate rise was inevitable. “I am not resigned to it at all and I don’t like interest rates going up, nobody does,” Mr Howard said.

During today's campaign launch he is again likely to stress that in view interest rates would climb still higher under a labor government, drawing comfort from the Reserve Bank's observation when it lifted rates last week that “growth in labour costs has been contained so far”.

But the qualifying words used by the Bank “so far” were new, suggesting that the Bank is becoming increasingly concerned about a wages It may put forward evidence of its concerns in this morning's 11.30am statement, further embarassing the government and necessitating some last minute amendments to the Prime Minister's speech.