Investment Bank JP Morgan has made a big call saying in its note to clients today that it thinks the Reserve Bank will raise rates next month.
The RBA board meets in Melbourne on Cup Day, 6 November, with its decision due out at 9.30pm the next day. Their action will depend on the third quarter Consumer Price Index, due out a week today from the Australian Bureau of Statistics. Another strong result will see the bank forced to lift rates to control inflation, a decision that would be made in an election campaign.
The bank’s chief economist, Stephen Walters, made his call as another investment bank, Macquarie, joined the chorus of commentators warning that the tax cuts and already tight economic conditions threatened to push up inflation. The comments came a day after two other banks, Goldman Sachs JBWere and Merrill Lynch issued similar warnings.
Mr Walters said in today’s note:
Core inflation is still rising, owing to the tight labour market and lingering capacity constraints. Also, food prices are soaring, energy prices are high, and housing and utility prices are climbing.
Growth in Australia’s economy has been above potential since 2002. Real GDP growth has averaged 3.4% per annum, but potential growth has been sliding, mainly owing to suboptimal productivity growth.
Under-investment in skills, infrastructure, and new capacity means that the economy’s spare resources have been shrinking rapidly. Indeed, the jobless rate has plunged to a 33-year low and, until recently, the rate of resource utilization was at a record high.
As a result, headline and core inflation are running in the upper half of the RBA’s 2- 3% target range; the sustained pressure on resources means that the ceiling of the range is likely to be breached in 4Q07.
The RBA has been raising interest rates since 2002. The deteriorating inflation outlook should be sufficient to trigger another tightening in November, even though the dysfunction in money markets has delivered a de facto tightening for some borrowers. Previously, we had forecast a December tightening.
Meanwhile, Macquarie Equities made similar comments, although in the end it thought that third quarter inflation, due to be released next Wednesday, could come in on the low side, meaning the pressure on the RBA might ease for a second rate rise in 2008. But that would only be postponing the rate rise to the new year when there would have to be “rate hikes” and that they would have to be “aggressive”.
Crikey yesterday reported that Goldman Sachs and Merrill Lynch warned their clients that the tax cuts would pressure interest rates.
And, there was further confirmation of the rapid growth ahead for the economy from the latest figures in the Westpac-Melbourne Institute Leading Index of Economic Activity, released this morning. It shows growth is picking up, thanks to consumer spending and strong employment growth, the two areas of activity that will be stimulated by the tax cuts from the Federal Government (and if they are matched by the Labor).
The Westpac-Melbourne Institute Leading Index of Economic Activity rose by 1.5 points in August, taking the annualised growth rate of the index to 5.6%. The index, which indicates the likely pace of economic activity three to nine months into the future, remained above its long term trend of 4.3% in August.
AAP quoted Westpac chief economist Bill Evans as saying that the August result surprised on the upside after the previous month’s result suggested the index may have been on a sustained downward path after what had been a long period of robust growth.
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