Okay, you might get the impression that I am a serious inflation hawk. Well, UBS's outstanding chief economist, Scott Haslem, presented the other side of the story on Friday. Before I preview Scott's work, let me say that Australia is well served by many good market economists. The quality of their sometimes unheralded work day-in-day out is surprisingly high. But you are hard-pressed to go past Scott and his team, and RBS's Kierean Davies and Fecility Emmett, if you are looking for original analysis on a weekly basis. Producing new and thoughtful research this regularly is bloody hard yakka. But these guys manage to do it much of the time.
Last week, Scott took the sword to those (of us) arguing that the RBA needs to get on the frog-and-toad and hike again pre-emptively if it is to have any hope of getting ahead of the curve and fixing its otherwise weak inflation-targeting record over the last decade. He makes many valid points, especially in relation to the significant comparative weakness of Australia's economy in 2010-11 relative to the 2006-07 episode when the RBA got head-faked by some soft data. He also highlights robust disinflationary forces in 2010-11 that were absent in 2006-07. (I guess one could respond that the impending capex boom is vastly largely than what we were facing back then.) Here are the thrust of his arguments:
"But we’d also argue that there is more underlying softness near term in the economy than the RBA seems prepared to accept, and that there is more significant near-term disinflationary pressure than the RBA seems prepared to acknowledge. In the end, the RBA’s objective is not to target “commodity price” inflation but “consumer price” inflation. And if the consumer remains cautious (in contrast to the RBA’s view), then there is unlikely to be much consumer price inflation. So until the consumer reveals less caution and more confidence about spending these ‘oncoming’ rivers of gold from the mining and capex boom, there’s little reason to be moving interest rates from their already mild restrictive setting.
At the moment, the economy at 2¾% end 2010 (RBA forecast) is clearly ½%pt below trend, and about 6 months behind the RBA rate cycle – which is already mildly restrictive. So while the focus of analysts remains on further RBA hikes around May/June this year, we expect the RBA to continue to focus on the cautiousness of the consumer, holding fire until there’s more evidence that the mining and capex boom is spreading ‘across the regions’ (see RBA Stevens, Monetary Policy and the Regions, September 2010). If policy was clearly ‘easy’ then there would be a stronger argument to bow to the strong medium term outlook by lifting rates even in the face of softer near term data. But policy is already mildly restrictive (and “appropriate for the outlook”, according to the RBA). So the economy is 6 months behind both where the RBA thought it would be and their current setting of policy… the economy needs time to catch-up to the RBA."
