The opening statement to the House of Representatives Standing Committee on Economics, Finance and Public Administration by the Reserve Bank Governor Glenn Stevens was released this morning, and it makes essential reading.

The early parts of Stevens’s opening statement cover the impacts of the resource boom, the concern surrounding the capacity restraints and the corresponding uptick in inflation in mid-2006 – all of which Henry’s readers should know chapter and verse.

Stephens’s evaluation of the current outlook is more crucial:

Most indicators suggest the economy expanded at a moderate pace through the second half of 2006. While housing construction remained a bit below average, engineering and non residential building have been very strong. Consumer demand picked up a little pace, and at present it is being assisted further by the decline in petrol prices. At the same time, the very serious drought has strengthened its grip on the rural sector, and farm production and incomes will be sharply lower this financial year as a result. The demand for labour has remained very strong, with higher than average increases in employment and some further decline in the rate of unemployment through the turn of the year.”

All of this should mean that domestic demand will rise at, or slightly below, trend pace over the coming year. With some export sectors expanding as additional capacity comes online, our central forecast is for growth in non farm GDP to pick up to about trend during the next couple of years. Total GDP growth will be lower in the near term because of the drought’s effect on the farm sector.

And, most importantly, on inflation: “With that outlook, the Board decided in February to maintain the existing setting of cash rates. We will be maintaining a close watch on what incoming information tells us about the prospects for inflation. The apparent softening in underlying inflation in the December quarter was certainly very welcome, but it is not as yet clear to what extent it signals a persistent, as opposed to a temporary, phenomenon.”

One of the pieces of more important pieces of incoming information is labour cost data and, specifically, whether it is showing any indications of wage-push inflation. As Henry highlighted on Monday, one of the most puzzling aspects of the domestic economy over the past year has been, despite the surge in inflation, the relative absence of rising wages.

This trend continued in the December Quarter, with seasonally adjusted wage price index rising by 4% – a rate that is considered satisfactory by the RBA. As this graph indicates, it seems that the Australian workers have weathered the “2006 oil shock”, and 30-year low unemployment rates, without widespread demand for higher wages. As a result, it appears our economy can maintain “miracle” status.

Read more at Henry Thornton.

Peter Fray

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