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.