FED:Swan talks tough, Stevens more soothing

AAP General News (Australia)
04-21-2011
FED:Swan talks tough, Stevens more soothing

By Colin Brinsden, AAP Economics Correspondent

CANBERRA, April 21 AAP - People will be forgiven for gnawing their fingernails in the
run-up to the May 10 budget given the heated political rhetoric over potential spending
cuts.

But one thing seems almost certain.

The Reserve Bank isn't about to inflict more angst on the public with an interest rate
rise any time soon.

While, Treasurer Wayne Swan continues to talk about his fourth budget being "tough",
the same cannot be said for central bank governor Glenn Stevens on the outlook for interest
rates.

"We'll be doing things in this budget that won't be popular," the treasurer told the
Queensland Media Club in a pre-budget address on Wednesday.

"Spending cuts are rarely vote winners. This will be a tough budget for one reason
and one reason only - it is what needs to be done for the economy and for the country."

In contrast, the Reserve Bank's April 5 board minutes released this week shouldn't
be giving borrowers sleepless nights.

The last line on the minutes was hardly an indication that the central bank is poised
to lift its cash rate soon.

"(Board) members ... did not see a case to change the cash rate."

There was none of the usually wording that would indicate a change was around the corner
such as "appropriate for the time being".

That's not to say there won't be one or two upward tweaks in interest rates before
the year is out.

Next Wednesday's consumer price index (CPI) shouldn't raise the collective heartbeat
of Governor Stevens and his team, even though at face value it will look pretty ugly.

Economists are expecting at least a one per cent jump in the March quarter CPI report,
which will lift the annual rate above three per cent, the top end of the central bank's
comfort zone.

But the Reserve Bank is fully prepared for this price shock, as it is for a weak outcome
for economic growth, or gross domestic product (GDP), for the same period when the national
accounts are released in June.

"In the short term ... the economic data were likely to be significantly affected by
the earlier floods and cyclone," the minutes said.

"Headline (CPI) inflation was likely to be quite high in the March quarter, while GDP
would be held down, to a greater extent than earlier assumed, by the lost coal production
and the delays in resuming mining operations."

"In reaching its decision, the board would look through these fluctuations."

A spike in food prices after the natural disasters in Queensland and a jump in oil
prices due to political conflict in the Middle East and north Africa are likely to be
the main driving force for the expected CPI rise.

Otherwise, as this week's international trade price data showed, the strength of the
Australian dollar - as it heads towards the stratosphere above 107 US cents - is largely
keeping the price of imported foreign goods in check.

The Australian Bureau of Statistics import price index rose just 1.4 per cent in the
March quarter to be only 0.2 per cent higher over the year.

Thursday's producer price index, which gauges the impact of cost pressures on what
businesses pay for materials, also showed that in the final stage of production inflation
is being domestically generated.

That said, the Reserve Bank will also be keeping a more watchful eye next week on underlying
measures of inflation, which are more crucial to the interest rate outlook.

These measures gauge whether inflation is becoming deep-rooted in the economy, excluding
volatile swings in items like food and fuel.

Commonwealth Securities chief economist Craig James expects there should be a clear
distinction between the CPI and the underlying outcomes.

"There is the rampant discounting undertaken by retailers in an attempt to get consumers
to part with their cash," he said.

"As a result the underlying rate may have only risen 0.6 per cent, keeping the annual
growth in the lower end of the two-three per cent target band, near 2.1 per cent."

So for the time being at least, the Reserve Bank can sit on the sidelines.

But there seems to be little sign that it is about to cut rates, even though it has
growing list of worries from overseas.

Given the outlook for the economy, in particular the high level of the terms of trade
and the prospective further large increase in investment, it considered current rates
were appropriate to ensure inflation remained consistent with its target in the medium
term.

But the recent tragic events in Japan will not only have an impact on Australian exports
to our second largest trading partner, but the central bank says the Japanese disaster
has increased uncertainty around the near-term global outlook.

"There were also other continuing uncertainties, including the sovereign debt problems
in Europe and the impact of higher oil prices on the large advanced economies where recoveries
were less well established," the minutes said.

The United States might be added to that list after international rating agency Standard
& Poor's warned the world's largest economy that its AAA rating would be at risk unless
it started reducing its budget deficit in the next couple of years.

The warning gave Mr Swan another reason to talk tough on the budget.

"What's happening in the US is only another reminder why it's so important for countries
to have a credible fiscal consolidation strategy," Mr Swan said in Wednesday's address.

"While we adopted our strict fiscal strategy at the height of the GFC ... the US is
struggling to put one in place now."

While he said he will take "no joy" in making cuts to the budget, an easier alternative
would be to put them off until later.

"But that would result in even harsher cuts down the track."

For once, the board minutes were so much more soothing."

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