Is inflation a pending threat to economic recovery?
July 31, 2009
Concerns about deflation are quickly giving way to fears of inflation as economic commentary turns from ‘will there be a recovery’ to ‘what type of recovery will it be’.
The latest inflation data from the Melbourne Institute has heightened worries of inflation, with the month of July recording the fastest growth in prices in the survey’s seven-year history. Inflation was 0.9 per cent for the month, although it remained beneath the 2-3 per cent annual target rate of the RBA at 1.9 per cent. This potentially leaves room for further cash rate reductions - although another cut seems further and further away with every new piece of data at the moment.
So the specter of inflation does loom large, but there are reasons to suggest that it will not soar in the year ahead, at least. Firstly, the Institute noted that a number of one-off rises might have contributed to the result in July. As a result, inflation figures in the vicinity of this month’s result appear unlikely in coming months.
Additionally, much of the Federal Government’s stimulus plans have been ploughed into the economy already, a far cry from countries like the US - where President Obama notes that much of the stimulus will flow in the latter half of the year.
The unprecedented amount of money flowing into economies to prevent what, at one stage, looked like being a depression is a threat, though, as it could quickly see inflation rise as people continue to sell off the US dollar and buy commodities. This could lead to a rapid increase in costs of production, inevitably leading to consumer price inflation.
An inflationary breakout in the near term could lead to higher wages, many being priced out of the housing market, interest rate hikes, and underemployment. In other words, a threat to sustainable recovery. Which makes the rest of the year crucial, as the economy must be able to show signs of real growth before inflation rears its head. The low cash rate presents the RBA with ammunition to counter inflationary threats, but being forced to use it prior to year’s end - as some now predict - would be far from ideal.
Professor Guay Lim, the head of the Melbourne Institute’s Applied Macroeconomics Research Program, believes that inflation is one of the major risks to the robust Australian economy.
“As the rate of growth in the Australian economy picks up, we will be watching out for three types of risk: (1) that inflationary pressure does not lead to wage break-outs which would have a deleterious effect on job creation; (2) that the now prevalent state of “under-employment” reflects only a temporary adjustment phase, and (3) that the current increase in housing activity does not turn into another asset price bubble,” he said.
In its Monthly Bulletin of Economic Trends, the Melbourne Institute indicated that the Australian economy could counter these risks. The latest consumer sentiment data and uplift in housing activity were seen as major positives and expected to lead to growth - albeit below average.
“We expect year-end GDP growth of around zero in the June and September quarters, followed by a soft rebound in activity of 0.9 per cent and 0.9 per cent in the December and March quarters,” the Institute advised.
The Institute has indicated the unemployment rate could climb to 6.4 per cent by the end of the year, which too could pose a threat to growth.
All that being noted, however, the prospect of unemployment rising to 6.4 per cent is nowhere near as alarming as the eight per cent bandied about by economists earlier this year.