Saturday 30 April 2011

Inflation? Where?

Last Wednesday (27/04/11) the RBA released its quarterly inflation figures. After a 0.4% increase in the previous December quarter, in the March quarter inflation rose 1.6%: shock, horror.

The reaction was immediate:

"The dollar soared [by an 'astounding' 0.5%!!!] to a new high yesterday [Wednesday, that is] after inflation increased by more than economists expected.  [emphasis added]
"The currency breezed past US108¢ to US108.52¢ (...)
"Analysts said the Reserve Bank might now consider raising rates.
" 'We've now seen the market pricing in a higher chance of a rate hike in the next 12 months,' a foreign exchange strategist at IG Markets, Chris Weston, said." (See here and here).

That increase puts the yearly inflation figure on 3.3%, against the 2.6% estimated for the year to last December.

So, people would feel justified to believe "soaring" wages are having the catastrophic inflationary effect mentioned in the last post, right?

Not quite. According to the ABS:

"The most significant price rises this quarter were for automotive fuel (+8.8%), vegetables (+16.0%), deposit and loan facilities (+4.6%), fruit (+14.5%) and pharmaceuticals (+12.5%). (...)

"Fruit prices increased by 14.5% in the March quarter 2011 mainly due to an increase of approximately 100% in the price of bananas during the March quarter 2011 due to shortages following floods and Cyclone Yasi. Vegetable prices increased by 16.0% in the March quarter 2011, driven by price rises in cauliflowers, broccoli, lettuce, pumpkin and potatoes due to damage to crops as well as the usual seasonal price rises." (Emphasis added).

In other words: largely supply factors drove these price rises, not a "soaring" demand caused by "soaring" wages. Thus, interest rate hikes would not solve the problem.

You don't need to take my word for it: among others, Ian Varrender and Michael Pascoe, from the Fairfax media, have made the same point. Prof. Bill Mitchell has argued along similar lines, but going into deeper details.

Mind you, both Messrs. Varrender and Pascoe (as Mr. Weston, above) see the need for at least one interest rate hike before the end of the year. I myself can't see any immediate justification, except for the "terrifying" labor shortage/"soaring" higher wages spectre, that is.

So, you might find this surprising, but these three gentlemen are among the inflation-targeting doves.

Believe it or not, at the other end of the spectrum, the inflation-targeting hawks appear to see an urgent need for immediate interest rates increases!

Terry McCrann, arguing for an interest rate increase next June: "They [the latest CPI figures] were seriously concerning in their own right. (...) Especially as the clear surge in inflation pressures came despite the anti-inflationary impact of the strong Aussie."

With due respect to Mr. McCrann, I have enormous difficulty getting around the idea of the Aussie dollar reducing the price of Queensland bananas. You see, I suspect QLD bananas are not imported.

Further, although the AU$ rose fast, oil and derived products prices rose faster, accounting for the AU$ failure to fully compensate the increase in oil prices.

For instance, in the month 30-03-11 to last Thursday, Brent crude oil spot rose from US$ 115/barrel (30-03) to 126.3 (ICE Futures Europe), for a 9.86% increase. In the same period, from US$ 1.0309, the Aussie increased to US$ 1.0974, in London: +6.45%.

Another inflation targeting hawk, Christopher Joye, has also argued about a likely interest rate hike, maybe as soon as May. His main argument is that core inflation has increased more than expected last year

He is right on that: nobody, last year, foresaw the Libyan crisis, or Cyclone Yasi. But this, to me, is irrelevant. The relevant questions are whether a higher interest rate would counter their effects, whether those effects are sustained and whether those effects are not simply adding noise to the series.

Mr. Joye does not consider those points, and I don't blame him: the answer could be negative to him.

But Prof. Mitchell (see link above) did consider these subjects. Speaking on noise::

"The special measures that the RBA uses as part of its deliberations each month about interest rate rises – the trimmed mean and the weighted median – also showed moderating price pressures.

"So what has been happening with these different measures?

"The annual growth in the weighted median was steady at 2.2 per cent in the March quarter having been at 3.1 per cent in the March 2010 quarter. The trimmed mean rose modestly from 2.2 to 2.3 per cent the same period.

"What that means is that there is no underlying price spike. The factors driving the headline rate (which I analyse next) are all volatile and ephemeral (food prices and petrol)."

Surely, this means that I believe the RBA will keep interest rates steady for much longer, right? Unfortunately, I fear Messrs. McCrann and Joye could very well be right.

Being an autonomous body, with unelected leadership, the RBA doesn't need a sound argument to make a decision, just like Messrs. McCrann and Joye seem to hold their views without a sound argument.

In other words: the RBA might lift interest rates for no other reason than "that's what central banks do when there's too much money", just like physicians used to prescribe leeches when patients had "too much blood".

Guillaume van den Bossche.
"Historia medica, in qua libris IV". 1639.

Or maybe, as Dean Baker said, it's just because workers could be getting uppity; except this time it would affect not only workers and small businesspeople, as I remarked in the previous post, but mortgagors, because housing prices are falling across the board in Australia.


03/05/2011. In its May meeting, the RBA Board decided to leave interest rates unchanged at the current level of 4.75%. See here.

Apart from the natural disasters affecting Australian agriculture in January, producing a short-term shortage of produce (yes, you guessed it: largely Queensland bananas) and sudden spikes in commodity prices (read here: oil), the Governor statement says:

"Growth in employment has moderated over recent months and the unemployment rate has been little changed, near 5 per cent. Most leading indicators suggest further growth in employment, though most likely at a slower pace than in 2010. Reports of skills shortages remain confined, at this point, to the resources and related sectors. After the significant decline in 2009, growth in wages has returned to rates seen prior to the downturn." Emphasis added.

So, dear commentators, journos, talking heads, pundits and bloggers, for the sake of everything that's sacred, stop selling the nonsense that workers in Australia are making cartloads of money.

Like, pretty please, with sugar on top?

To the RBA guys: I love to be proved wrong. Keep it up. At least until the end of this year.


  1. Magpie,

    You nailed it!

    I wrote this on Facebook earlier in the week: With the volatility in food and oil & the flow on effects of the GFC still passing through the Australian economy I foresee a rate cut to induce spending or a recession, unless exports (oncoming commodity bubble) takes off.


  2. Thanks for the comment!

    Although I agree with the idea that a interest rate hike is not justified right now, I am afraid the RBA could do anything, even taking the worst possible decision.

    Let's hope you are right, Senexx.