All pumped up about inflation
There is no doubt the RBA needs to hike interest rates soon as the momentum on inflation is building rapidly. Not only was the December quarter CPI a shocker, rising 0.8%, but it followed a stonking 1.2% rise in the September quarter. Anyone with a pocket calculator can see this means that annualised inflation was around 4% over the second half of 2013.
And this is with the cash rate at a record low 2.5%, fiscal policy moving from tight to neutral, the Australian dollar going from fair value to undervalued and house prices rising at a pace that must be playing on RBA Governor Glenn Stevens’ mind.
Recall – the RBA is an inflation targeting central bank, with an objective to keep inflation between 2 and 3% over the cycle. With house construction set to boom, with consumer spending accelerating, with business expectations rising, exports surging and now inflation looking to exceed the top end of the target during 2014, it needs to move monetary policy to neutral. It might be useful to also note that the world economy is looking better by the week, at least in terms of GDP growth.
This means the RBA needs to get the cash rate back to 4% or so over time (neutral), starting with a hike in the next month or two with follow up moves at reasonably regular intervals over the next year or 18 months.
Making matters more disconcerting today was the lift in the underlying CPI, which jumped 0.9% in the quarter lifting after a 0.7% rise in the previous quarter. Another couple of high-ish inflation results will see underlying inflation test the upper bound of the RBA target band.
This is where we take stock. Pretend for a moment you are a member of the RBA Board and the following facts are presented to you:
- Annual inflation has accelerated from 1.2% two years ago to 2.7% now with the momentum suggesting a break above 3% is now all but certain.
- House prices are rising at an annual rate of 10% and show few if any signs of cooling.
- The Australian dollar is more than 15% lower than a year ago and export volumes are rising strongly.
- Fiscal policy is roughly neutral now, having been massively contractionary over the past two years.
- The global economy is strengthening.
- Housing construction is on a surge.
- Retail and other consumer spending are accelerating with retail sales rising at an annualised pace of 7% in the last 4 months.
- Commodity prices in Australian dollar terms are rising.
Would you really be doing your job if you left the cash rate at a record low 2.5% for too much longer?
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