Monday, February 11, 2008

First reaction: "shock"

"The Reserve Bank has shocked us with their obvious extreme concerns about the inflation outlook.

While the Governor's Statement last week referred to inflation moderating next year, we note that the degree of moderation in their forecasts points to it falling from 3.5% in 2008 (RBA and Westpac forecast) to 'only' 3.25% in 2009. That means that on the Bank's own forecasts, inflation will hold above the top of the 2 to 3% band for more than two years. Even by June 2010, the expectation is only that inflation will be back at 3%, the top of the target band.

The decision to highlight specific point forecasts so far out in contrast with the previous policy of defining ranges, emphasises how worried the Bank must be. For example, we would have expected them to have at least maintained the forecast we had for 2009 in the last SoMP of 2.75%-3% for the June 2010 projection. We have consistently argued that the inflation picture has become so concerning for the Bank that a very early additional rate hike will be required.

That action seems to be very clearly signalled in the concluding paragraph of the introduction to the Statement, where the Bank concludes that " ...the risk of inflation remaining uncomfortably high for some time is considerable. Absent a further shift in economic risks to the downside, therefore, monetary policy is likely to need to be tighter in the period ahead."

We expect that the next move is likely to be in March. This closing paragraph to the introduction does give the Bank an 'out' if the domestic data or the global economy (specifically the developing world) was to show some very sharp reversal in momentum over the next few weeks. However, we cannot reasonably expect such a significant development in such a short period of time that would convince the Bank, which by its own forecasts is facing more than two years of inflation exceeding the top of its target range, to delay further action."