Kevin Rudd and John Howard are racing an unlikely conjunction of economic events as they head towards decision day on November 24, events that will constrain whoever wins the poll, no matter what they might say this week in their official policy launches.

It’s all about inflation and rising price pressures in the booming Australian economy.

The Reserve Bank made clear this morning that for the next two years at least, we can expect little change in inflation around its present high level of 3% and therefore little change in the current level of interest rates of 6.7% for the bank’s cash rate, or higher, if need be.

The returning credit crunch in the US, the sagging US and European economies, the slipping value of the US dollar, and continued inflation in China, and persistently strong price pressures here are all ganging up on the Liberals and ALP to delivery a reality check post November 24.

Just in case the politicians weren’t getting the message, the Reserve Bank made sure it laid out its inflation concerns in its latest Quarterly Monetary Policy statement.

Cloaked in central banker caution, it’s a rejection of the multi-billion dollar bidding war now consuming federal politics.

The underlying message isn’t ”go for growth”. According to the RBA it’s all about interest rates, high rates, at the present level of 6.75% or more, if the economy doesn’t slow. More growth is the last thing we want, according to the RBA: slowing growth and rising unemployment will be the order of the day for 2008 and 2009 and probably into 2010.

The bank can’t find any silver lining in the conjunction of events, with the strong Asian economies, especially China, continuing to fuel our boom and the pressure on scarce resources, plus the impact of the drought.

Even a slowing world economy next year won’t be enough to help us and virtually the only thing that could ease the pressure would be a worsening in the current uncertainty in global financial markets. responsive to tight capacity conditions than it has been to date.

Might this be an election to lose?

The bank said that looking into the early months of 2008 “both headline and underlying inflation are likely to exceed 3% on a year-ended basis as a result of high CPI outcomes that have already occurred.”

The bank said in its statement accompanying last Wednesday’s interest rate decision that it saw headline and underlying inflation hitting an annual rate of 3.5% in the March quarter of next year.

“Looking further ahead, and taking into account the recent monetary policy decisions along with other factors such as the higher exchange rate and the expected moderation in global demand, the Bank projects that inflation will settle at a rate a little below 3% over the next two years.

“Somewhat lower outcomes could eventuate if global economic conditions prove to be weaker than expected, which might occur if there were further significant disturbances in global financial markets.

“But it is also possible at this stage of a long economic expansion that inflation will be more difficult to contain, particularly if domestic demand does not moderate,” the bank said in the introductory statement to the quarterly report.

That’s the warning to the parties, the government and the community generally that unless economic growth slows from the present rate of growing around 5% annually in the domestic economy over the next couple of years, interest rates will have to rise further to bring inflation under control.

And to make sure we got the message, the bank expanded on this view in its more detailed look at inflation:

“Over the medium term, upward pressure on the inflation rate should diminish, helped in part by the rise in the exchange rate, assuming it is sustained, and some moderation in the pace of demand growth. But with demand growth still close to trend, and pressure on capacity only diminishing gradually, inflation is unlikely to decline far.

“Underlying and CPI inflation are accordingly both forecast to be close to 3% during 2008 and 2009.”

Peter Fray

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Peter Fray
Editor-in-chief of Crikey

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