In 2006, rising fuel prices, uncomfortable inflation and a “1,000-year drought”, made it a tough time for our “nirvana economy”. However, the first month of 2007 has seen a palpable change — the price of a barrel of oil has settled below US$60, the rate of inflation has fallen and there have even been some brave souls predicting soaking rains for our drought-affected farming regions. Indeed, almost 14% of Henry’s readers thought South-East Australia would experience soaking rains in 2007 — make sure you vote in Henry’s latest climate change survey.

Today’s Roy Morgan Consumer Confidence Rating shows the extent to which the story so far in 2007 has been positive, with the February reading continuing the strength seen in January. After a 6.5 point jump to a very positive 123.9 in January, the February Roy Morgan Consumer Confidence Rating declined only slightly to 123.8.

With inflation likely to moderate through 2007, Henry expects more of the same positive sentiment and, with consumer spending making up around 60% of the Australian economy, one would expect the nirvana economy to return. However, with yesterday’s record low unemployment rate and today’s strong housing finance data, this result is far from guaranteed.

In today’s AFR, Alan Mitchell highlights that, before the beginning of 2005, “full employment” was defined as having an unemployment rate of 5%. That has been blown out the water now, as we have had less than 5% unemployment for almost a year, and the downward trend continues.

It could be that either the official rate of unemployment considerably underestimates the amount of unutilised labour in the economy, or the Government’s Workchoices legislation has encouraged employees not to be too demanding about pay and conditions, and thus wage-push inflation hasn’t been too serious. Henry believes that it is a bit of both.

There is another option, and that is that wage-push inflation lags behind the unemployment rate, but after almost a year, this is looking less and less likely. Apart from sporadic anecdotal evidence of rising wages, specifically in the booming mining industry, the threat is not yet serious.

Nevertheless, Henry would expect the RBA to keep a close eye on the cost of labour, and therefore it is likely to retain their hawkish outlook on inflation.

Today’s housing data certainly confirms this, with seasonally adjusted dwelling finance commitments jumping by 1.9% in December, reversing the negative trend in the second half of 2006 and almost 1% above market expectations.

In other Central Bank news, the Euro Central Bank voted to keep rates at 3.5% overnight, but ECB President Jean-Claude Trichet used the phrase “strong vigilance” on monitoring euro zone inflation, which obviously means the finger is close to the trigger. This is the tone Henry would expect in the RBA’s Quarterly Statement of Monetary Policy due on Monday.

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