Days of low interest rates are over

INFLATION is unlikely ease over the next three years and so the days of low interest rates are over, according to leading economic forecaster and industry analyst BIS Shrapnel.

BIS Shrapnel’s Long Term Forecasts, February 2008 Update predicts inflation will remain above 3% for the rest of 2008, through 2009 and into 2010.

 

BIS Shrapnel’s senior economist and chief forecaster Richard Robinson said monetary policy is being employed in an environment of strong demand, capacity constraints and labour shortages.

 

“The strength of employment and the boost from successive income tax cuts is making the Bank’s job harder, as these factors are helping to cushion household incomes. Demand won’t fall away, but given the indebtedness of the household sector it is inevitable that we will see consumer spending slow.

 

“The upshot is that the RBA will be successful in reigning in the economy in the short-term. It won’t stop until it is. The moderation in investment and spending will in turn slow demand for labour and take pressure off wages,” he added.

 

“The problem is that it will only be a temporary measure because in the absence of a recession, we won’t see a blow-out in the unemployment rate — our modeling suggests it won’t reach 6% in this cycle. Consequently, it won’t take long for labour markets to tighten-up once again,” he continued.

 

According to BIS Shrapnel, whilst business investment is nearing its peak residential construction is waiting in the wings as the next driver of growth.

 

Robinson said the upswing in dwelling construction has been held-back by rising interest rates, but once the current tightening cycle peaks and slowing non-dwelling construction provides room for a come-back, he expects a long-overdue strong round of residential construction to start later this decade.

 

“Australia’s main inflationary concern remains the lack of slack in the labour market, which will be compounded by the ageing population.

 

“Measures to boost labour supply including increasing participation, encouraging people to delay retirement and immigration policies will also provide an extra buffer, as will measures to enhance labour productivity. However, while ever the Australian economy is near full employment, the potential for a wage-cost push in inflation will remain a threat,”

 

Robinson said wages growth has not been the trigger of inflationary pressures in the current tightening phase as labour market reforms and institutionalised setting of wages have dampened growth.

 

However, the ongoing tightness of the labour market means wages growth will remain within a 4-to-5% band, which will make it harder for the RBA to keep inflation within its 2-to-3% target band.

 

BIS Shrapnel said the additional demand has pushed up the cost of energy and food. World supply has been responding and as extra capacity comes on-stream, prices will moderate.

 

BIS Shrapnel forecasts slowing investment and consumer spending, and a boost to productivity from prior investment, will push the unemployment rate above 5% through 2010.

 

But, as renewed residential construction activity drives momentum in the economy, and GDP growth strengthens again, Robinson expects the unemployment rate will drop back to current levels of close to 4% by 2012.

 

“A low unemployment rate means that it wouldn’t take much of a pick-up in investment and employment for the economy to again exceed its speed limit. The result is that we are likely to see shortened investment cycles accompanied by rising inflation and escalating interest rates.

 

“We are nearing the top of the current interest rate tightening cycle, but it is only a localised peak. The stubbornness of inflation, due to labour constraints, means that we are unlikely to see a return to a low interest rate environment in the absence of the recession,” he concluded.

 

Australian Property Journal