Fear grips the Reserve Bank - Aussie Stock Forums

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  1. #1
    Rotaredom wayneL's Avatar
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    Jul 2004

    Default Fear grips the Reserve Bank

    The bastids waited too long to raise.


    Fear grips the Reserve Bank

    August 05, 2006 03:15am

    THE Reserve Bank faces the gravest threat to inflation since the early 1990s, warning it may turn into a wage-price spiral that would need to be reined in with higher interest rates.
    In what economists described as warning that the "inflation genie" may escape, the bank admitted the biggest risk to the economy was that inflation became entrenched as trade unions demanded bigger pay rises and businesses sought to recover rising costs by putting up prices.

    The bank has not faced such a challenge since 1994 when the economy was just emerging from recession.

    Its response at the time was to raise rates from 4.75 per cent to 7.5 per cent in the space of just four months, leading then Opposition leader John Howard to proclaim that the government had delivered "just five minutes of economic sunshine".

    On Wednesday, the Reserve Bank raised interest rates 25 basis point to 6per cent, the highest level since 2001, in an effort to contain a worrying spike in inflation.

    Economists believe the bank could lift rates again before the end of the year, a scenario they warn could scupper the recovery in national house prices, particularly in the eastern states.

    Major banks yesterday moved to lift their variable mortgage rates amid warnings that house prices will fall in every city if rates were to rise a third time this year.

    Sydney would be worst hit, with prices falling up to 10 per cent, said Louis Christopher, general manager of Australian Property Monitors. Prices in Brisbane and Melbourne would fall up to 18 and 15 per cent respectively. "If there is a third rate rise this year, it's going to be very nasty," Mr Christopher said.

    The fear among economists and the Reserve Bank is that rate rises do not contain inflation -- which is already running above the bank's 2-3 per cent comfort zone -- as businesses put up prices to recover higher costs and workers demand higher wages as a result.
    "The real concern about inflationary expectations is if it translates into higher wage claims and higher prices, that's when you let the inflation genie out of the bottle with a wage-price spiral that feeds on itself," ANZ treasury economist Warren Hogan said.

    The bank said yesterday it would be watching the economy over the next few months to see whether its two interest rate rises this year were sufficient to contain the risk.

    It says underlying inflation will rise to 3 per cent, which is right at the top of the band it is expected to defend, and stay there for the next two years.

    However, this does not include extreme price movements, such as soaring petrol and banana costs, which would push the inflation rate up to 4 per cent.

    The bank said the most important risk - one that would force it to raise rates further - was that people started building the higher 4 per cent figure into their expectations.

    "There are upside risks associated with the domestic economy operating close to capacity," the bank said. "Most importantly, the current high level of headline inflation may lead to some pick-up in inflation expectations."

    It said there was some sign this was happening already. It cited a survey showing trade union officials expect inflation to average 4.2 per cent this year and 4.1 per cent next year. Three months ago, they were counting on inflation of only about 3.3 per cent. A Melbourne Institute survey conducted in July also shows that consumers expect inflation this year to be 4.1 per cent.

    The Reserve Bank said financial markets were pricing "inflation-proof" bonds on the basis that prices would rise at a rate of 3.5 per cent.

    The Reserve Bank says wages are also rising faster than is generally believed. The official wage price index shows wages are rising at an annual rate of 4 per cent, up from 3.5 per cent a year ago.

    However, staff shortages are leading companies to offer bonuses, rapid promotion and more attractive work arrangements to attract and keep staff. Including bonuses, wages rose by 1.2 per cent in the first three months of the year.

    The bank said the risks to inflation were "evenly balanced". The danger of rising inflationary expectations were offset by a possibility that the world economy may slow sharply.

    It said that so far, business had been taking a lot of the pressure of higher costs on the chin, accepting lower profit margins rather than trying to pass costs on to consumers. Excluding the mining and finance industries, business profits have fallen in each of the last three quarters and are now below their long-term average level.

    "It appears that businesses' margins are being squeezed by rising material and labour costs," it said.

    However, business costs are continuing to rise. The Reserve Bank said business leaders had been warning of increasing costs of products derived from oil, such as plastics and packaging.

    The Reserve Bank believes that excessive demand from both consumers and business is creating a temptation for companies to pass on costs.

    Although Reserve Bank governor Ian Macfarlane said earlier this year that the Government could afford tax cuts, the bank's review of the economy said the big-spending budget was adding to consumer demand.

  2. #2

    Default Re: Fear grips the Reserve Bank

    Here, here Wayno! I wonder what the oil prices are doing to the US... (Bush Family excluded ) Somethings gotta pop that bubble.

  3. #3
    Billie Jean is not my lover Realist's Avatar
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    Jun 2006

    Default Re: Fear grips the Reserve Bank

    Wayne, I must admit I love seeing interest rates go up. As one who missed the property boom (and yes a bit bitter about it ) I like to see the ones who caught it and made money off investment properties etc. get smashed back to reality. I do feel for those families that bought recently though.

    And as I do not own a house the higher the interest rate the better for me, I have money and will just wait till houses go down more before buying, and the higher the interest rate the cheaper the house.

    So my question Wayne, do you like to see interest rates climbing?

    Ohh, and I agree the RBA is trying to shut the gate after the horse bolted, why not rise them during the housing boom in Sydney 5 years ago to cool the market then? Were they 5 years too late?
    Never buy anything because it has gone up in price.

  4. #4

    Default Re: Fear grips the Reserve Bank

    Rate rises hurt EVERYONE, not just home owners. If you dont own a home, then you must be renting. What do you think happens to rents when rates rise? They go up to cover the shortfall.

    "...will just wait till houses go down more before buying, and the higher the interest rate the cheaper the house."

    eh? says who? explain 1988 - 1990 then when rates were 17% while property skyrocketed.

    "the RBA is trying to shut the gate after the horse bolted, why not rise them during the housing boom in Sydney 5 years ago to cool the market then? Were they 5 years too late?"

    Oh dear. another armchair economist. Again you show a complete lack of even basic economic understanding. It is virtually impossible to "steer" the money supply where you want it to go. The RBA needed retail spending to increase, to keep the economy from stalling. Unfortunately, the excess funds created an asset bubble instead. One possible solution to this is to include mortgage repayments into the CPI. This would have alerted the RBA to inflation much earlier. But really, the data collected is delayed, and also money takes time to filter through the economy. So its kinda like driving round a windy road while very drunk.....your reaction times are bad and often you hit the guard rails & bounce off in other direction. Its impossible to keep in the centre of the road all the way round.

    If the RBA didnt drop rates 5 years ago, retail spending would have dried up. The property boom probably still would have gone on. The FHOG added to the problem, and only the lucky first recipients got any benefit from it.

    Secondly, the RBA doesnt change policy based on house prices as you suggest.

    Thirdly, higher rates means inflation. Inflation is BAD for YOU and less so for those with big debts. So you have money saved. You probably believe higher rates mean more interest which means more money. This is true, but it ignores inflation. In real terms, you are probably worse off. One day you will need that money to buy a house, and with inflation raging the future price will be in the millions.
    Meanwhile, those with big debts panic in the short term, but over the long term they are doing well. Think about this; lets say you bought a house in 1980 for 30k. At the time, you think "wow, what a massive debt.......I will never pay that off in my lifetime"
    But nowadays thats less than the average wage. You could pay that off in a year. Of course interest would be a lot, and the actual amount repaid over the life of the loan would be a lot more, but the point is, inflation and high rates go hand in hand, and higher in both is not really so different in terms of the wealth effect.

    Few people understand that the massive U.S debt will be repaid by inflated dollars. The Fed secretly WANTS hyperinflation. Its the only way they can pay it back. Whats a few hundred billion in debt now when in 10 yrs thats one months GDP?

  5. #5
    Billie Jean is not my lover Realist's Avatar
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    Jun 2006

    Default Re: Fear grips the Reserve Bank

    Well Money tree, yes I do believe as interest rates go up house prices in Sydney will go down.

    Explain why that wont happen please? Because from what I can tell it is happening already (it could be a coincidence but I doubt it)

    I also believe at the moment in Sydney you are better off renting and waiting. Rental yields are low, and therefore rate rises harm renters less than owners.

    Would you buy now in Sydney or wait and rent for the next 6 months, and why?
    Never buy anything because it has gone up in price.

  6. #6

    Default Re: Fear grips the Reserve Bank


    The point money tree was trying to make is not about whether you should buy now or in 6 months etc etc but more along the lines of the effect inflation has on a home loan.

    People that have held property for the medium term or longer are those that stand to benifiet the most from high interet rates (subject to being able to service the debt).

    If interest rates go up to 10% and this is linked to high inflation then it stands to reason that rents go up by a similar amount as does everythng elsre (ie food etc) This in effect reduces the mortage by the same amount.

    What he is saying is that a 400,000 mortage will quite likely be a years wage in 30-40 years and the higher the inflation rate the quicker that happens.

    Obvisly this also effects cash holdings in that the higher the inflation rate the less your money is worth in a years time. If we find ourselves in a position where rates are at say 9% and inflation is at 10% then Money is actually losing it's buying power despite on paper growing.

    As for buying a house or not, each to there own but it's that old saying time in the market not timing the market. (which is not to say you can't try and time it a little too)

    As a side not there was an article in the west a few days ago regarding some african country (or the likes, can't remember exactly) where there inflation rate is at 1200% (yep 1200%) and they have just deleted three zero's from there curency becuase the reserve bank's computers can't handle dealing with billions of trillions of digit's in transactions. The exchange rate was some ridiculas figure of trillions of millions per US$
    The greatest trick the devil ever played was convincing mankind he does not exist.

  7. #7

    Default Re: Fear grips the Reserve Bank

    All this talk about inflation really depends on what is inflating. Wages? Asset prices? Living costs?

    If you're in debt then high wage inflation is exactly what you want, as long as you've fixed interest rates. Under these circumstances, inflation pretty much takes care of the debt for you in "real" terms.

    Historically, the masses lose during asset bubbles. I expect this one to be no different. Speculation, and that is exactly what buying land in the expectation of a rise in vaule is, is a zero sum game. It transfers wealth but does not create it. For every winner there must be a loser. A lesson that the losers always learn the hard way.

    I don't wish anyone harm, but those who bought houses at the top of the market using large variable rate loans can't say they weren't warned by the likes of the RBA and the Treasurer that the trend of rising house values and falling interest rates would reverse at some point.

    IMO the RBA won't be keen on anything that sees living costs and wages soar and as such they'll slow the economy to prevent it. Odds are that slowing ends in recession IMO. House prices do not tend to rise in recessions. Indeed they do the exact opposite.

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