Financial markets have reverted to their usual post-CPI complacency and have largely priced out the risk of further RBA tightening before year-end. Markets have been lulled into a false sense of security by subdued activity data, seemingly consistent with a moderation in domestic demand, but which are in fact unambiguously inflationary.
The sharp decline in building approvals in March to their lowest level since May last year will maintain upward pressure on rents, inflation and house prices. But the chronic national shortage of dwelling stock is largely a function of past under-investment that is baked in the cake. We still expect private dwelling investment on a national accounts basis to rise 2.6 per cent in the March quarter and contribute 0.2 percentage points to March quarter GDP growth. Dwelling investment can contribute positively to demand, while still being inadequate to alleviate the shortages putting upward pressure on rents on inflation.
The March private sector credit release saw credit for investment housing post its slowest annual growth on record, suggesting that residential property markets will remain chronically supply-constrained. Eventually, rising rents and house prices should induce more supply, but for now, there is no sign of the expected supply response in the data. Investment housing aside, private sector credit growth posted respectable gains in March, suggesting that tighter credit conditions are still not yet unduly constraining overall credit growth.
The 0.5 per cent rise in nominal retail sales in the March quarter was more than fully accounted for by retail price inflation, with retail trade volumes declining marginally over the quarter. Weak retail trade volumes are merely symptomatic of the strength of current inflation, not a predictor of future inflation outcomes. Those going in search of reasons for Australia’s high retail price inflation need look no further than the broader inflation trends in the economy. Prosecuting big business for lowering prices, as the Australian Competition and Consumer Commission keeps threatening to do, would be another perverse own-goal in the ‘war on inflation.’
Next week’s RBA Board meeting should keep the official cash rate unchanged at 7.25 per cent, but will see the first official comment on the March quarter CPI outcome. The RBA’s quarterly Statement on Monetary Policy
released on Friday will quantify the expected impact of the March interest rate hike and March quarter CPI on future inflation. This is likely to see only modest changes to the forecast profile for inflation.
The Statement on Monetary Policy should help the government rationalise another revenue-hoarding budget. The government has been grooming the press gallery to expect an underlying cash surplus for the 2008-09 financial year of $17 billion, which suggests the government will ‘surprise’ us with surplus on budget night of around $20 billion or around 1.7 per cent of GDP, equalling that seen at the peak of the last cycle in the late 1980s.
Since the previous government was already running surpluses of 1.5-1.6 per cent of GDP for every year between 2004-05 and 2006-07, this will be a trivial tightening in fiscal policy relative to past budget outcomes and only a modest tightening relative to the forward estimates contained in the previous government’s Mid-Year Economic and Fiscal Outlook.
In any event, as the following chart from Professor Sinclair Davidson's of the Treasury’s revenue forecast error in recent budgets demonstrates, the forward estimates should be taken with a grain of salt:
As the chart (Source: Sinclair Davidson (2007), ‘Fiscal Illusion: how big government makes tax look small,’ Perspectives on Tax Reform 15, Centre for Independent Studies: Sydney) notes, an unbiased revenue forecast should yield an average forecast error of zero, not the large and persistent positive forecast errors seen in recent years. Applying recent revenue forecasting errors to the expected starting point budget surplus could set the stage for an unprecedented fiscal tightening.
Contrary to press gallery mythology, the previous government ran the tightest fiscal policy in nearly 20 years and one of the tightest fiscal policies among comparable developed countries, but this did nothing to
prevent an acceleration in inflation. Fiscal policy has been and will remain irrelevant to inflation and interest rate outcomes, which are a function of loose monetary policy and developments in global capital markets.
The government has promised to hoard revenue in excess of the forward estimates in the Future Fund, even though the Future Fund is already on track to meet its original mandate in relation to public sector superannuation liabilities. We might legitimately ask, what are further contributions to the Future Fund actually for? Prospective budget surpluses will be a boon to the Futures Fund’s private sector asset managers, but will do nothing to augment the supply side of the economy or combat inflation.
Next week, the TD-MI inflation gauge is released Monday, forecast at 0.1 per cent month-on-month and 3.9 per cent year-on-year compared to 4 per cent year-on-year previously. The first quarter ABS established house price weighted capital city median is forecast at 2.7 per cent quarter-on-quarter. April ANZ job ads are also released Monday. Tuesday sees the release the March trade balance, with a deficit of $2.429 billion forecast, driven by a 0.6 per cent month-on-month decline in imports and a 4 per cent month-on-month rise in exports, although weather-related disruptions to commodity exports may have persisted into March, weighing on export volumes. April employment is released Thursday, forecast to rise 25,000, with the unemployment rate seen re-testing the recent 34-year lows at 4.0 per cent.