January 24th, 2008
Inflation shock puts pressure on rates
Australia’s 3 million home buyers are likely to be hit by
another interest rate rise %26#151; the third in six months %26#151;
after inflation rose to its highest level in 16 years.
Most economists believe the Reserve Bank will act to lift rates
when its board next meets on February 5 %26#151; unless global share
markets continue to dive.
Inflation figures released yesterday were far worse than
expected, as higher petrol prices, bank charges and housing costs
pushed the underlying inflation rate up by 1.05% in the December
quarter, and 3.6% for the year. Petrol prices alone rose 14.3% for
the year.
The Reserve Bank is expected to respond within a fortnight by
raising official interest rates by 0.25 of a percentage point,
adding $50 a month to repayments on an average $250,000 home
loan.
In addition, mortgage holders have been hit with rises
unilaterally imposed by banks and other lenders, which are paying
more for the money they lend to home buyers as a result of the
high-risk loan market meltdown in the United States.
But they believe an increase is less likely if global
sharemarkets resume the falls of recent days.
Markets began to rebound yesterday, with doom giving way to
gloom. Twelve days of falling share prices that had knocked $300
billion off the value of Australia’s top 200 stocks were partly
retraced, as the S%26amp;P/ASX200 Index climbed by 225 points, or
4.3%.
The turnaround came after the US Federal Reserve intervened to
stop the rout on global stockmarkets by slashing 0.75 of a
percentage point off US interest rates, cutting its benchmark
federal funds rate to just 3.5%.
But that will cut little ice with Australia’s Reserve Bank,
after the Bureau of Statistics reported that inflation is running
even higher than markets had expected. At 3.6%, underlying
inflation is now clearly outside the Reserve’s target band of 2% to
3%.
The Reserve as usual made no comment on the data yesterday, but
in an uncompromising speech in London last Friday, Reserve governor
Glenn Stevens played down the falls on financial markets and warned
that “uncomfortably high” inflation is the key problem facing the
economy.
After being briefed yesterday by Mr Stevens and Treasury
secretary Ken Henry, Treasurer Wayne Swan also played down the
likely consequences of the financial market turmoil for the
economy, and emphasised the imperative of bringing down
inflation.
“As we’ve seen in recent days, we’re not immune from turbulence
in the United States,” Mr Swan said.
“But all the advice I’m receiving is that we are well placed to
withstand that international turbulence.
“Today’s CPI figures show why the Rudd Government has made
tackling the inflation challenge a significant priority. It’s
pretty clear that the primary cause of underlying inflation is
basically the twin investment deficits: skills and
infrastructure.
“These pressures have been building from the beginning of 2006.
These figures are proof that elevated inflation is the Liberal
Party’s parting gift to the Australian people.”
But the bureau figures show that in 2007, half the growth in
overall prices came in just two areas: housing costs and rising
finance charges. And that was before the banks made their
controversial rises this month to pass on higher lending costs to
home mortgages.
In 2007, the cost of financial services grew by 5.3%, home
purchase costs rose by 4.3%, rents by 6.4%, electricity bills by
5.7% and water bills by 5.9%. By the end of 2007, the banks had
already raised lending rates to all customers except those with
mortgages.
Food prices rose just 1.2%, with falling fruit prices balancing
out the rising cost of bread, milk and cheese.
Shadow treasurer Malcolm Turnbull said Labor was playing the
blame game and spinning “fairy stories about the important
challenge of inflation”. Inflation, he said, was mainly due to
rising global prices for oil and high housing costs, for which the
states were responsible.
In sharp contrast to Mr Swan, Mr Turnbull told the Reserve Bank
board it would be prudent to “stay their hand, and watch and wait
for a little while longer” rather than raise interest rates next
month.
“What is happening elsewhere in the world %26#133; will inevitably
slow growth in Australia because we live in an integrated global
economy,” he said.
A Reuters survey of 22 financial market economists, however,
found 14 expect the Reserve board to raise rates at its February
meeting, while three others expect it to delay only for a month or
two. Five think there will be no rise.
The Westpac-Melbourne Institute index of leading indicators
further highlighted the momentum in the economy, rising sharply to
6.4% in November.
Westpac chief economist Bill Evans said rising household incomes
from higher commodity prices, rising wages and tax cuts would drive
the economy in 2008.