This article is from the Australian Property Journal archive
In a change of forecast, JPMorgan now expects the RBA to raise the cash rate 25bp to 6.0% on 2 August.
Previously, the forecast was that the RBA would wait until September so that officials could examine the July retail spending report at the end of August, which is the first to include the impact of the Budget’s generous tax relief and benefit increases.
Last week’s robust employment report for May, however, which revealed a record low unemployment rate, means the RBA instead is likely to tighten as soon as possible after the 2nd quarter CPI report, which is released on July 26.
Escalating inflation concerns mean that the dominant risk is that the RBA moves in July.
The RBA has established a consistent track record since the start of formal inflation targeting in 1996 of tightening policy at the first Board meeting following the release of CPI data showing high or rising core inflation.
Indeed, on all 11 occasions the RBA has tightened since 1996, the core CPI — measured by the trimmed mean — was in the top half of the RBA’s 2-3% target range and/or was accelerating. The average lag between the release of a CPI report showing high or rising core inflation and an RBA tightening is 29 days.
The shortest lag was 5 days in May 2000; the longest was 70 days in April and October 2001.
The RBA extended this track record last month by tightening on 3 May just 7 days after the 1st quarter CPI report showed headline inflation at 3.0% and core inflation accelerating into the top half of the target range.
The August 2006 Board meeting is scheduled for 1 August, just 6 days after the scheduled release of the 2nd quarter CPI report.
JPMorgan believes that the 2nd quarter CPI report will show headline inflation above 3% and another acceleration in core inflation, which already is in the top half of the target range. This will be enough to trigger a second tightening – rising inflation will have rendered redundant waiting the extra month to see the July retail report.
Rising core inflation is the main trigger for another RBA tightening, but there are other reasons for the RBA to tighten in August.
Capacity is tight even outside the labour market, the disinflation forces from offshore are weakening — imported inflation now is broadly in line with domestic inflation, consumer spending has rebounded in the last few months, credit growth is accelerating, activity in the housing market has improved, and house prices in the major east coast cities has stopped falling and are booming in some markets.
Moreover, last week’s employment report showed the strongest rise in employment since September 2004. Employment growth is notoriously volatile from month to month – employment fell in April, but the unemployment rate usually is more reliable and is a better indicator of the tightness of the labour market.
Last week’s drop to a record low unemployment rate of 4.9% indicates that the labour market is as tight as a drum – RBA officials started becoming anxious about rising wage growth a long time ago when the economy’s skill shortage problem was much less acute.
Partly offsetting these inflationary forces are the recent drop in the Australian equity market – previous gains delivered a substantial wealth effect to households – and the imminent soft patch in the global economy.
Even with these dynamics, though, last month’s policy tightening showed that RBA officials have limited tolerance for rising core inflation.
With this in mind, the only real element of doubt over the next RBA policy move is the timing, and an August tightening now looks more likely than September. Only an unexpectedly benign 2nd quarter CPI report at the end of July would keep the RBA on the sidelines.
This looks unlikely, though, given soaring prices for fruit and vegetables, high energy prices and mounting evidence of second round price effects as producers rebuild margins squeezed by higher transport costs by raising retail prices.
By Stephen Walters, chief economist with J.P. Morgan Securities.*
