Hawks and doves

So, it’s rates day. The usual suspects are out pounding the pavement. All over the media, currency boffins are calling for hawkish rhetoric from the RBA. But they’re all outdone by Australia’s one-man inflation fighter, former deputy governor of RBA, Henry Thornton, who calls for a hike today:

Wage claims are on the march, with a newspaper report focusing on the relationship between wages growth, goods and services inflation and productivity growth.

Quoting Stephen Roberts, a senior economist at Nomura Australia in Sydney, the report said the Reserve Bank has had a threshold of about 4.5 per cent for wage growth, a combination of 2 per cent productivity and the 2.5 per cent midpoint of the central bank’s inflation target range.

That limit now was probably 4 per cent or lower, as productivity slowed to less than 1 per cent, Mr Roberts said.

Yet wages grew 3.9 per cent in the three months to December 31 from a year earlier, the fastest pace since the first quarter of 2009.

This is another case in which the global financial crisis came just in time to save the Reserve Bank from the embarrassment of an inflationary surge. The authors report a jump in wage claims of 15 per cent in the resources sector, according to a professional recruitment manager.

In February, the Construction, Forestry, Mining and Energy Union sought pay increases of up to 24 per cent over four years, and the Communications, Electrical and Plumbers Union is seeking annual pay rises of 5 per cent over the next three years, almost double the inflation rate.

The board of the Reserve is on the horns of a sharp dilemma: its senior officers have signalled (deliberately or otherwise) no immediate rate hikes are in prospect; its non-executive directors will worry more about obstacles to growth than the threat in inflation; and its ex-officio member, the Secretary of Treasury, has to decide if he is an independent-minded inflation hawk or a Treasury official loyal to the party that appointed him.

Further rate hikes will push the dollar higher, further squeeze the manufacturing and tourism sectors, and make life more difficult for small businesses generally.

Then there is asset price inflation to worry about.

Global share prices have resumed rising after a brief correction to the great Greenspan-Bernanke bubble.

The Reserve Bank can do nothing but give advice to Ben Bernanke on this matter.

House prices in Australia have apparently stopped rising but there is a general housing shortage that will be made worse as strong population growth is faced for a time by subdued construction. The government is spruiking a tough budget, which will allow for a flood levy and big new carbon tax.

The Reserve will be tempted to leave interest rates unchanged until the budget is delivered and assessed. That would be a mistake, but an understandable one.

If the Gillard government cannot persuade the major unions to go easy on wage claims, it will quickly be seen as an important mistake.

Hmmm, I have a lot of time for Henry. As a former Reserve boffin, his understanding of RBA dynamics is unmatched.

It is interesting to note too that he’s generally regarded to have been the other prime candidate for the top job when Ian Macfarlane was appointed. In my view, overlooking him was an historic mistake. Bubbles Macfarlane was far too dovish throughout his tenure and is wrongly remembered as an asset inflation buster. Rather, he should be recalled as the godfather of the housing bubble. If Henry Thornton had been selected, I do not think we would have the same bloated housing market legacy today.

On today’s piece, however, I see Henry as ahead of the curve. There may be some wage claims, but there are always such claims, and the unions involved are clearly in the economic sweet spot whose capital is the Pilbara.

I don’t see, yet, much evidence of generalised wage claims, especially not in the wider services sectors. As well, for the time being employment growth appears to have peaked, suggesting that labour is available.

Moreover, yesterday’s TD Securities/Melbourne Institute inflation survey had nothing in it to worry the RBA.  Indeed, its mix of flood-affected food price rises and falling core inflation completely endorsed the RBA’s February forecasts:

Inflation is consistent with the medium-term objective of monetary policy, having declined significantly from its peak in 2008. Recent data show underlying inflation at around 2¼ per cent in 2010. The CPI rose by about 2¾ per cent, reflecting the once-off effect of the increase in tobacco excise. These moderate outcomes are being assisted by the high level of the exchange rate, the earlier decline in wages growth and strong competition in some key markets, which have worked to offset large rises in utilities prices. The Bank expects that inflation over the year ahead will continue to be consistent with the 2–3 per cent target.

The flooding in Queensland and Victoria is having a temporary adverse effect on economic activity and prices. Some production of crops and resources has been lost and some other forms of economic output have also been lower in the affected areas.

Prices for the relevant commodities have risen and are likely to remain elevated in the near term. Resumption of production is occurring at differing speeds by region and industry. In setting monetary policy the Bank will, as on past occasions where natural disasters have occurred, look through the estimated effects of these short-term events on activity and prices. The focus of monetary policy will remain on medium-term prospects for economic activity and inflation.

Still, as The Economist points out this week, the RBA is determined to keep inflation within its target band and sooner or later that can mean only one thing:

As prices rise quickly in Australia’s booming industries and regions, the RBA can meet its inflation target only if prices elsewhere fall. Over the past 18 months the RBA has raised its key interest rate by 1.75 percentage points. These hikes, according to Joaquin Vespignani of Barclays Capital, have no effect on the mining industries, which sell and borrow abroad. Higher rates and a stronger currency do, however, hurt firms in manufacturing and construction, as well as states, such as Victoria and New South Wales, where these sectors loom.

In principle the RBA could change its inflation target, ignoring prices in the mining state of Western Australia and perhaps the Northern Territory. One outside economist even floated the idea with the RBA. “They just started talking about cricket,” he said.

For the time being, however, the dollar is doing all of the hard work even with the RBA in neutral (with a hawkish bias). Trade exposed manufacturing, a large employer, is in full recession and has been for for six months. Moreover, the disleveraging project is in full roar, with housing clearly weak and getting weaker, building approvals in the toilet, retail sales growth still flat in February and growth rates in credit aggregates a hair’s breadth from 30 year lows.

In short, we already have the inflation/deflation economy The Economist describes.  The RBA is in no hurry.

Houses and Holes
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  1. I’m so glad the dollar is doing all the “hard work” by wiping out manufacturing. I don’t think Henry needs to worry about a wages explosion in Australia’s factories.

    I repeat, the rest of us must suffer so mining can prosper. Welcome to the Quarry Economy.

        • Of course! This is Australia and our first and only remedy for any economic difficulty is to impose a tax. A flood levy, a carbon tax, what next – an NBN tax? Yep, impose a selective differential tax on the only area of the economy currently flourishing (apart from bureaucrats and tax advisors). Mining has been an inherent component of the economy in this country since colonization. Taxes have been applied to these businesses as any other. And taxes paid. Successive governments have had the opportunity to create a genuine SWF designed to ensure long term generational gain from the various natural resources mined/extracted from this land. None has. The current one won’t and let’s be honest, would not be capable of it. Yes, currently mining is booming. But it will not last forever. It is cyclical, always has been. What then? An RSPT fixes nothing.

          Perhaps what should be addressed is the decline in our manufacturing capabilities. This decline is a direct result of the realities of globalisation, union incompetence and corporate greed. And a rather cozy amalgamation of two of these factors are governing the country now.

          Surely there is more to suggest than a tax?

  2. The trajectory of these hawks is as predictable as ever – Wage pressure >> High inflation >> High inflation >> Skills shortage>> Therefore We need more people !!
    When are we getting off the growth treadmill?

    • Continuing your trajectory…

      We need more people >> housing shortage >> we need more housing concessions to encourage construction.

      • Yes, that trajectory is even more predictable and gives us an insight into the hidden agenda/motivations of the bank economist hawks when they open their mouths and scream inflation!!.
        But I didn’t want to end every comment into something that talks about house prices 🙂

    • And blame the Asian immigrants for taking all our jobs and causing our home properties…

      Win Win Win!

      • Ah! I mean Causing our home properties unfordable to average Aussies… I need my coffee..

  3. And then – there are the headlines that must be ignored by the mainstream economists, policymakers and RBA.

    Youth Unemployment is Australia’s Economic Achilles’ Heel

    Quote:”Australia boasts one of the world’s lowest jobless rates and is the self-proclaimed envy of the developed world, but it has a dirty little secret: one in six of its youth is unemployed.

    An eye-popping 16 percent of Australians aged 15 to 24 are not working, more than three times the overall jobless rate — an often-overlooked and paradoxical statistic that could prove costly for an economy that faces acute labor shortages.

    “It’s shocking given that the Australian economy is doing so well,” said Kumar Palghat, the founder and portfolio manager of Kapstream Capital.”

    Obviously – we need a pool of unemployed people so wages growth can be kept in check. No, not in the mining industry.

    • Yes its interesting that many economists and econ-journalists haven’t looked into this “underlying demand” of labour.

      We also have shockingly low educational/vocational skills amongst the whole labour force, and a very large amount of underemployment.

      The wage-spiral theory will die a quick death once the above is realised AND the impact of a housing slowdown/landing/crash affects the two most important employment sectors: retail and construction.

  4. My suggestion: instead of mucking around with federal profit-based mining taxes (which the mining industry has virtually nullified by huge capital expenditure) the feds should be telling the WA and Qld state governments to hugely hike their royalties. This would slow production in the mining industry and limit its distortion of the rest of the economy (solves the bleating about their GST share as well). If the state governments were smart, they could put a hefty proportion of the proceeds into sovereign wealth funds.

  5. Everyone, including the RBA is BEHIND the curve on inflation. It’s happening. It just isn’t in the statistics yet.
    However, whatever the RBA does re interest rates will not effect the rate of inflation. Inflation will not be caused by wages. The public service and the powerful will still get their inflation adjusted wage rises anyway no matter where interest rates are. It will be the small businesses and the people who work in them who will get shafted and not get the inflation adjusted wage rises. Higher interest rates will just shaft them more.
    Inflation is already written in unless the A$ goes to say $1.1 to $1.15 this year without a concurrent rise in commodity prices.

    Having said all that I’m one of the renegades that think interest rates are set on totally the wrong basis and ought be much higher than they are anyway. How you get from one basis to another is a problem in this insanity.

  6. Why do we have a reserve bank? Do we need it? If the ‘market sets’ the short term interest rates – there is no need for an extra layer of unelected bureaucracy to set the price of money.

    The RBA is not better/worse than the FED – it is just as political and incompetent. It exists to manipulate the banks via monetary policy and ensure the financialization of society and country.

    The history of the RBA speaks for itself. It has sit on its hands and watched the housing bubble grow from the eighties.
    Now, its sit on his hands while the Australian economy is being hollowed-out by the ‘mining boom’.

    Monetary policy – administered by central banks and aided by government fiscal policies – has been a disaster and will continue to sow the seeds of the next GFC.

    Time to re-think and re-align the governing institutions, their functions and responsibilities.

  7. Australian households are highly indebted, and you can reduce the debt two ways : via an increase in saving, and also via inflating the debt away.

    Demand for Food and energy prices are inelastic, and the prices are determined by a global market. Increasing interest rate in Australia have a very minor effect on prices, this is why the RBA prefer the ‘core inflation’ measure.

  8. Rate hike or not. Only those who over extend themselves have to stress over it. Oh and retail. Sorry.

  9. No rise.

    Car sales are down 1% for the month on PCP. This is an interesting figure, to say the least.

    Trade deficit “unexpectedly” hits $205 million in February, according to ABS.

    “Economists’ forecasts had been for a surplus of $1.1 billion for February.”

    Dollar down 0.5 cent as a result.

  10. Good point Prince but why do we bother with this Trade Deficit or Surplus number? The only number of significance is the Current Account. The Trade Account is just trumpeted because occasionally it doesn’t sound too bad and occasionally a surplus.
    The Current Account is always an alarming Deficit and it seems to get a feint whisper each month.