The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Tuesday, January 18, 2011

Four more rate hikes according to Blocker

Former senior RBA official, HSBC Chief Economist Paul Bloxham, is a hawk. And I reckon he is probably the best public cue we have on the RBA's thinking. Blocker believes the Queensland floods will be (perversely) a net positive for economic activity and national incomes, and further amplify already worrying inflation pressures given that unemployment has dropped to its so-called 'full employment' level. In this context, it will be fascinating to see where Q4 CPI prints since it will be a mostly pre-floods read on prices. The market is expecting a benign result, so people will start having kittens if the pre-floods inflation numbers look ugly (I'd also note that statistically it is relatively rare to get three consecutive quarters of very low core inflation). Blocker’s base-case is for four more rate hikes, with at least three coming in 2011:

“Our working assumption is that the floods will reduce GDP by 0.8% in Q4 2010 / Q1 2011, followed by a boost to GDP of 1.5x this amount over the following two years. Our forecast for GDP growth over 2011 is a still strong 4.0% (4.2% previously). By mid-2012, we believe GDP will have made up all lost ground due to the floods…

We also expect the floods to boost inflation. Food crops were damaged and there will be additional pressure on wages due to reconstruction. We have raised our forecasts for headline inflation to 3.4% over 2011 and for underlying inflation to 3.3% (both were 3.2%). As a result we still expect the next rate rise by the RBA in Q2, with the cash rate at 5.75% by Q1 2012.

For inflation it’s almost all upside…Food prices will rise due to the floods. This rise is against the background of food markets which were already pretty tight. Queensland accounts for about 30% of fruit and vegetable production in Australia. It is also a large producer of wheat (~10% of Australia’s output). However, the RBA will look through any food price effect on headline CPI, as they did when banana prices rose due to cyclone damage in 2006. The more important issue is that with the labour market already around full employment, additional expenditure on reconstruction and repair will put further upward pressure on wages, and thus on inflation. Indeed, the labour market is particularly tight for males, likely reflecting that the construction and mining industries are already operating at full capacity. This is the main effect that has led us to revise up our forecasts for underlying inflation. The price of insurance is also set to rise, which will put further upward pressure on inflation. Over 2011, headline inflation is now expected to be 3.4% and underlying 3.3% (both up from our previous forecast of 3.2%). Aside from economic output, disasters also affect prices. The effect of reduced supply puts upward pressure on prices, often even during the event. Destruction of goods during the crisis leads to shortages afterwards which also push up prices. The pressure that reconstruction efforts can put on wages drives additional upward pressure on prices. Insurance premiums tend to rise. For inflation it’s almost all upside!

This disruption to supply has led to a sharp rise in coal spot prices. And as the loss of exports is likely to be permanent – lost exports will not be caught up due to capacity constraints – the rise in coal prices is expected to be fairly sustained. This is a key point. Because demand for coal is fairly price inelastic, the export disruption will probably lead to a net rise in revenues. If coal contract prices rise from their current USD210 per tonne, to say USD300, and production goes back to normal levels, it will take less than three months to make up lost revenue. After that, the floods will have had a net positive effect on incomes.”