Thursday, October 23, 2008

What if inflation hits 5 per cent?

It has. So what?

The Treasurer has declared victory in the war against inflation as the official rate hits 5.0% - double the Reserve Bank’s target.

Prices are now climbing faster than at any time since 1995, apart from the spike when the GST was introduced in 2001.

The Reserve Bank’s preferred measure of inflation, the so-called underlying rate, hit 4.7% in September - its highest point since the recession of 1991.

The acceleration means that prices are now climbing faster than wages, sending buying power backwards.

The Treasurer Mr Swan greeted the news by declaring that while inflation was historically high, he believed it had peaked...

“That is the view of the Reserve Bank and if you look at what's happening in terms of global commodity prices and global growth I think that is an accurate prediction,” he said.

Private sector economists agreed, the Commonwealth Bank’s Michael Blythe saying that financial meltdown and the risk of a global recession would “fix” Australia’s inflation problem.

“Inflation typically peaks and then turns down during slowdowns or recessions,” he said. “Rising unemployment takes the heat out of markets.”

Australia’s 5.0% inflation rate in the year to September would have been an even-higher 5.13% had it not been for a one-off drop in the recorded price of childcare as a result of the government’s decision to boost the 30% Childcare Tax Rebate to 50%. The move pushed down the recorded price of childcare 23% from July.

The fastest-growing prices during the quarter were those over which consumers had little influence. Petrol was up 2.0%, electricity up 4.9%, property rates and charges up 6.1%, and rents up 2.1%.

By contrast the slower-growing or falling prices were those that weaker consumer demand was able to influence. The price of men’s clothing fell 1.9%, the price of children’s clothing 2.1%, and the price of audiovisual equipment 3.9%.

The rate of inflation on imported goods fell during the September quarter despite the lower dollar, suggesting that retailers are paring back margins in order to keep customers.

“We expect this process to intensify as firms have less pricing power and feel less able to pass on cost increases in full,” said ANZ economist Warren Hogan. “Weaker employment will also help push down inflation.”

Mr Swan refused to speculate about the future of employment, saying the government would update its forecasts in its Mid-Year Economic and Fiscal Outlook, due “within the next month”.

Appearing before a Senate estimates hearing Treasury official David Gruen revealed that his department had conducted no formal economic modelling during the lead-up to government’s $10.4 billion economic stimulus package.

“We are dealing with a situation of substantial disruption in credit markets. With the best will in the world it is extremely difficult for formal models to come to terms with such events, he said. “It is a situation which calls for judgement.”

The futures market is still pricing in an 80% likelihood of an interest rate cut of 0.50 points at the Reserve Bank’s Melbourne Cup day board meeting despite the elevated inflation rete..

“Concerns about inflation have been overtaken by fears about slumping growth,” said Citibank economist Paul Brennan.