One of the critical things to note about the likely (near certain) interest rate hike from the RBA on 7 November is that it will have absolutely zero, zilch, nothing to do with the massive tax cuts promised by the Howard/Costello government earlier this week.
The reason is simple. The Coalition might not win the election and the impact of those tax cuts if indeed they are ever delivered will not be felt until 1 July 2008.
How daft would it be for the RBA to hike rates on 7 November only to have the government tossed out on 24 November and replaced with the Rudd ALP!
The interest rate hike in November will be the result of the tax cuts announced in the May Budget and delivered on 1 July 2007, together with other well documented issues that are adding to inflation at present.
Recall that the Budget in May this year saw a cumulative $20 billion of income tax cuts pumped into FY2007-08 and a further $25 billion scheduled to paid in 2008-09. With this as the backdrop, as soon as the RBA saw inflation lift (with June quarter data) and it knew this sort of stimulus was in the pipeline, it hiked rates to their highest level in more than a decade. That rate hike in August took the cash rate to 6.5%.
This policy response from the RBA follows the pattern of the FY2006-07 Budget which saw tax cuts (and some poorly targeted spending and middle class welfare) come through. The RBA hiked on 3 occasions in 2006.
Of course there are other factors at play in the monetary policy mix – a shortage of housing and the resultant surge in prices and dwelling rent is adding to inflation, as is the elevated level of wages growth that is the result of a skills shortage which is partly a function of an under-funding of education and training for many years.
What’s more, the world economic strength is unrelenting. Of note on this latter point, much of the inflation impact of the strong world economy is being defused by the AUD heading to US$0.90, but nonetheless, it is a factor boosting corporate incomes and activity in Australia.
If the Coalition win the election and the income cuts outlined earlier this week are delivered, there is a very good chance that the RBA will need to hike interest rates beyond the current 6.5% (and soon to be 6.75%) to at least 7.0%. We have been flagging this for some months noting as a risk the cash rate being lifted to “7 point something” in 2008. We stick to that view as we await the election policies to evolve as well as watching the other drivers of monetary policy.
Of course, we still need to see what the Opposition ALP is offering by way of tax policy before we can make any strong statements on what it might mean for economic activity and inflation pressures. They have, however indicated a more conservative approach to fiscal policy, so let’s wait and see.
Linked to all of this will also be whether there are any microeconomic policies addressed at the skills shortage (education and training), housing policy, infrastructure spending and the like to see whether either side of politics is working to try to lift Australia’s productivity performance and with that, limit some of the inflation pressures that have been pumped up by easy fiscal policy for too long.