Inflation was the first word of the first paragraph in the introduction to the August statement of Monetary policy from the Reserve Bank: that seems so long ago now as the bank battles to ease Australia into a sharp slowdown that will see growth in 2009 lower and slower than this year.

This morning’s statement, the fourth this year, saw inflation not mentioned until the fifteenth paragraph, so dramatically has the outlook for the world and Australian economies changed since August. The US, UK, European and Japanese economies are slowing rapidly or are in recession. China overnight revealed an $A872 billion reflation package for the next two years to try and boost growth above 8% and keep it there.

Understandably, the RBA’s focus is now on growth, and the emerging lack of it here and around the world. Falling commodity prices, falling export income means slowing growth next year.

The central bank hacked half a per cent of its August growth forecasts and now expects annualised GDP growth of 1.5% for 2008, 1.5% to June 2009 and 1.75% to December 2009. That compares with the previous forecast for 2%, 2.25% and 2.50%, respectively.

Non farm growth will actually fall to just 1% this calendar year and 1.5% for the period to June next year.

So it’s no wonder, the RBA has cut rates 2% since September as the world and Australian economies have slowed, leading to that 0.5% cut in its 2008 economic growth forecast and a large 0.75% chop in its 2009 growth estimate.

The RBA sees the economy lower and slower through all of 2009 and its end of year forecast of 1.75% GDP growth is below the 2% for this year.

Today’s statement started with these worlds: “World financial markets have come under severe stress in the period since the last Statement,” and that’s still the big story as the credit crunch drags down growth around the world, and inflation.

While the RBA see consumer price inflation (CPI) and underlying inflation falling in 2009, the timetable for the expected decline to its 2%-3% target band has been pushed out six months to December 2010, from June 2010, when both measures are expected to reach 3%.

Annualised underlying inflation is now seen at 4.5% this year, 4% to June 2009 and 3.5% to December 2009. That compares to an earlier forecast for 4.5%, 3.75% and 3.25%, respectively.

But inflation remains close to the top of the list at the RBA, as it made clear at the end of the introduction to the statement:

In reviewing the stance of policy each month in the period ahead, the Board will be seeking to strike the appropriate balance between avoiding an unduly sharp weakening in demand and the need for inflation to fall back to the target over a reasonable period.

That means the central bank is warning that sometime next year it will start putting inflation back to a key weighting for monetary policy, once it has protected the economy as best it can from the slump. But not quite yet because it still sees a strong chance that economic activity and demand in the economy will slow further.

In summary, world financial market developments and economic prospects have moved rapidly in the period since the last Statement.

The renewed financial turmoil which began in the second week of September materially altered the balance of risks and raised the prospect that global economic conditions could be significantly weaker than previously assumed.

Given the weakness in the global economy, prospects are that growth in domestic spending and activity will remain below trend for some time. In addition, while commodity price increases were adding to costs in the period up to the September quarter, it is increasingly clear that the global commodity price cycle has peaked.

A slowing in global prices of manufactured goods also appears likely, though the recent depreciation of the Australian dollar represents a significant countervailing influence.

On balance it appears likely that underlying inflation is now reaching a peak in quarterly terms and that it will begin to decline over the next few quarters.

But don’t rule out another rate cut next month. Some economists have 0.25% penciled in, but credit markets have 0.50% on the cards (a quarter for December and a quarter for January when there’s no RBA board meeting.

Peter Fray

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