The Australian
economy continues to “power on”. The fresh news was the literally shocking
growth of producer prices in the June quarter, and then the correspondingly bad
result for consumer prices. Monetary policy needs to be tightened further and
probably will be this month.

The list of
developments supporting the case for monetary policy tightening is

  • Consumer inflation in the year to June reached 4.0 %. Even the
    Reserve Bank’s preferred measures of “underlying” inflation are rising, and
    average just a tad below 3 % in the year to June.
  • Producer prices rose by
    4.5 % in the year to June, noticeably above expectations.
  • Costs are
    beginning to escalate, especially in mining but many government officials are
    also achieving strong wage settlements.
  • Unemployment is at a thirty-year
    low and businesses report shortages of labour of all sorts.
  • Business fixed
    investment is growing strongly, again especially in mining, adding to pressures
    on demand for labour and offering the promise of stronger export growth before
  • Australia’s terms of trade remain
    high and may yet rise further from current levels. This means incomes are
    rising faster than production, supporting overall demand.
  • Credit growth is
    accelerating, particularly for businesses, to a close-to-unsustainable
  • Generous tax cuts have supported consumer demand despite expensive
  • Finally, markets are expecting a rate hike, with the relevant
    “market probability” quickly rising to virtually 100% following last Wednesday’s
    CPI release.

What could stay
the Reserve’s hand? The Treasurer recently renewed his anti-rate-hike
jawboning. In the early 1970s Treasury similarly misdiagnosed the causes
of rising inflation – and failed to tighten monetary policy – and this was an
important precursor to the election of Australia’s most economically
illiterate government.

“I suppose a
nuclear bomb dropped on Tehran might give them cause to pause,” an old
hand said late last week. Short of a stunningly bad geopolitical event, the
real question is how many rate hikes will be necessary. Delay so far will once
again mean interest rates will be higher than would otherwise have been
necessary. We shall very likely know more tomorrow when the Reserve raises
rates and offers a short explanation. Even if this is not the case, Friday will
see the next Monetary Policy Statement, when all will
be revealed.

Henry Thornton.

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