Mr Swan has admitted Rudd's government can do nothing about inflation for a few years. International economic situation being what it is. Such issues weren't a big problem for the Howard Government, which notably shielded Australia from many of the problems associated with economic downturns in Asia, or from the technology correction, or from the war on terror. But then the Howard administration had anti inflationary policy. Rudd is hamstrung by the fact that he doesn't know what he is doing.
During the last election campaign, Rudd claimed that Mr Howard had been lucky during his government's term. Sadly, we are discovering that Rudd is unlucky.
Rates pain for two more years, says Swan
ReplyDeleteBy Scott Murdoch
AUSTRALIA faces up to two years of interest rate pain after inflation burst through the Reserve Bank's safety zone to hit 3.6 per cent yesterday.
The result makes an interest rate rise next month a near certainty.
Wayne Swan described the surge in underlying inflation, the biggest in 16 years, as extremely serious and warned it would take at least 18 months to bring the problem under control. Hinting at massive cuts in spending in the 2007-08 budget, the Treasurer also called for trade unions to accept the need for wage restraint.
But with the inflation figures showing large increases in the cost of housing and fuel that are likely to put heavy pressure on the mortgage belt, Australian Council of Trade Unions secretary Jeff Lawrence insisted that an increase in living costs had to be considered in wage claims.
The announcement that inflation was racing ahead of the 2-3 per cent range targeted by the RBA put the brakes on a rally on the Australian stock market.
Following losses of $110 billion on Tuesday, the market opened strongly yesterday, buoyed by the announcement that the US Federal Reserve was acting to ease jitters sparked by the sub-prime credit crisis and cutting interest rates by 0.75 percentage points.
Australian investors leaped upon the US move to add 6 per cent to the All Ordinaries index, but the inflation news pared back the gains to 4.3 per cent by the close of trading.
Mr Swan blamed the surge in inflation on former treasurer Peter Costello, accusing him of making the risk of higher interest rates a "parting gift" to thenation.
The Treasurer said the problem highlighted the need for budget cuts even sharper than the Government's promised $10 billion "razor gang" savings, given that extra spending could add to the obvious inflation pressures. "What I would say to everybody - quite urgently to employers, employees and to unions - is that we will need to see some restraint to get us through this inflationary problem," Mr Swan said. "That is why the Federal Government has to lead the way."
Mr Swan would not speculate on his budget, refusing to rule out cuts in the defence budget despite a previous assurance to the contrary by Finance Minister Lindsay Tanner.
He also warned that the Government could not produce a quick fix, noting that the Reserve Bank and the Treasury were forecasting elevated inflation, both headline and underlying, "at or around the RBA target band" for the next 18 months.
"The CPI figures show why the Rudd Government has made tackling the inflation challenge a priority," he said.
As business groups backed Mr Swan's call for wage restraint, Mr Lawrence said there was no evidence that wage increases were causing inflation. "We have got a decentralised enterprise bargaining system and negotiations will take place and all the parties will look at the various factors, and increases in the cost of living is clearly one of them," he said.
"They (inflationary pressures) are the result of international pressures and the failure of the previous government.
"Clearly, workers and unions are entitled to take that into account."
JP Morgan's chief economist, Stephen Walters, said workers demanding higher wages would be one of the major drivers of future inflation pressures.
"If you're a firm and labour costs are your biggest costs and are going up, consumers are in good shape, then you can pass on the costs through higher prices - there's inflation right there," Mr Walters said.
BT economist Chris Caton said the Reserve Bank, the board of which will meet on February 5 to consider a rate rise beyond the current rate of 6.75 per cent, faced the dilemma of managing inflation while the global economy faced a slowdown as the US approached a recession.
The financial markets increased the odds, from 16 per cent to 46 per cent, of the RBA moving rates, which economists said was a "line-ball call".
"The RBA has a real problem on its hands. If the only thing you know was the inflation news, there's no way you couldn't raise rates," Dr Caton said. "If, on the other hand, the only thing you knew was the state of the world economy, there's not a way in the world that you'd be thinking of raising rates."
Citi head of economics Paul Brennan said the momentum of the Australian economy showed policy action from the RBA was needed to slow conditions. A rise will be the 11th since the current tightening cycle began in 2002.
"We believe the rise in the annual rate of underlying inflation is sufficiently large to force the RBA to tighten," Mr Brennan said. "The strength of the economy growing at above potential is a key source of the inflation pressures."
MME Capital managing director Tom Elliot said the Australian share market could be further spooked by the likely rate rise.
"It won't be good for the market. Investors won't like it, and I think the bounce has been overdone because nothing really has been fixed," Mr Elliot said.
Opposition Treasury spokesman Malcolm Turnbull said Mr Swan's warnings could alarm households and markets. "Wayne Swan is almost schizophrenic in the way that he talks about the economy," he said.
"One minute he says that the Australian economy is still strong and an in a great position to withstand international shocks, and then with the next breath hesays we are headed for financial peril.
"He has actually exacerbated our economic problems and he shouldn't be -- he should be speaking in a measured and balanced way."
The emergency rate cut in the US ordered by the Federal Reserve revived the Australian market yesterday after the $110 billion wipeout on Tuesday.
The S&P/ASX200 ended up 225.5 points (4.34 per cent) to 5412.3 while the All Ordinaries rallied by 223.6 points (4.28 per cent) to 5445.6.
Mr Swan was briefed by Reserve Bank boss Glenn Stevens and Treasury Secretary Ken Henry in his Canberra office yesterday after the US emergency rate cut. The economic officials reassured the Treasurer that Australia's reliance on Asia, particularly China, would absorb external world economic shocks.
Short-cut to market confidence
ReplyDeleteBy Greg Ip
BEN Bernanke blinked. The US Federal Reserve chairman, who normally tries to avoid reacting directly to financial markets, saw global markets in freefall, and on Tuesday abruptly orchestrated the single deepest cut in the Fed's main interest rate target in more than two decades.
The move shored up confidence, at least for the moment. US and many global markets quickly rebounded from huge losses in response to the three-quarter percentage point cut, to 3.5 per cent, in the target for the Federal funds rate.
But in a sign that risks to the US and global economy remain strong, the Fed hinted that another rate cut next week was likely. The central bank's moves may be too late to stop the US from entering recession, as many economists now forecast, but it may make any recession milder and shorter.
By acting so explicitly in response to market developments - just a week before a scheduled meeting to decide on rates - the Fed is running a risk. Investors may view the steps as panicky, and undermining the goal of the rate cuts. And investors may come to judge the Fed's success narrowly, by how the stock market, rather than the economy as a whole, performs.
Still, Fed officials agreed on the emergency move during a videoconference call convened hastily on Monday evening by Dr Bernanke. It came after he spent Monday in the office, despite the national holiday, watching the fallout as Asian and European markets plummeted, and consulting with aides. Futures markets on Monday were predicting a 4 per cent plunge on Tuesday in US stocks.
Dr Bernanke's main concern was that investor fears of an economic catastrophe could become self-fulfilling.
Another big drop in US stocks, on top of a 15 per cent decline since last October, would represent a hit to household wealth on top of eroding home values. Falling asset prices could force banks to take more write-downs, further eroding capital and constricting credit.
Dr Bernanke believed the Fed should try to short-circuit the negative psychology, and that it stood a better chance by acting right away instead of waiting a week. It was the first time the Fed has cut rates between meetings since the aftermath of the terrorist attacks of September 11, 2001.
The Dow Jones Industrial Average, down as much as 464 points early in the morning, recovered later to close down 128.11 points, or 1 per cent. European markets, which were falling steeply for a second straight day, reversed course and closed higher on the Fed's action. "Appreciable downside risks to growth remain," the Fed said in a statement, vowing to "act in a timely manner as needed to address those risks".
Futures markets see a high likelihood of another half-point cut, to 3 per cent, at the meeting scheduled for next Tuesday and Wednesday, and see the Fed bringing its target as low as 2 per cent by year end.
"The sense was that we were facing a meltdown," said former Fed governor Laurence Meyer, now at forecasting firm Macroeconomic Advisers. "That was the reason for trying to get out in front rather than trying to sit out on the sidelines."
The move would be "pointless" if it merely shifted a scheduled rate cut ahead by a week, Mr Meyer added. The aim, he predicted, was to get the rate lower by month's end than it otherwise would have been. He predicted a half-point cut next week.
Dr Bernanke's rate cut is a telling sign of the urgency with which policy makers are responding to the risk of recession. The Bush administration is pushing for a fiscal stimulus package of $US145 billion ($167 billion) composed primarily of temporary tax breaks.
Treasury Secretary Henry Paulson told the US Chamber of Commerce in response to a question on Tuesday that the Fed's rate cut was "constructive ... That should be a confidence builder".
The odds of recession are rising and some economists believe the US has already entered one or is about to do so. "The best forecast now, based on guesstimates of first-quarter data, is that we're not in a recession right now," said Robert Gordon, a Northwestern University economist who sits on the academic National Bureau of Economic Research committee which officially dates recessions. But he said odds favoured a recession starting late this quarter or next quarter. Merrill Lynch predicted that the economy would contract in each of the first three quarters of the year.
Today's economy shows some signs that are common to most recessions: stock prices are falling; long-term interest rates are dropping below the level of short-term rates; housing construction is declining; and the unemployment rate is up sharply.
But some usual indicators are not flashing recession. Employers have not trimmed employee work weeks, as they commonly do when demand trails off; initial claims for unemployment insurance have been dropping recently, and inventories aren't unusually high, which makes it less urgent for manufacturers to scale back production.
The Fed move marks a radical shift for Dr Bernanke. Since August, the Fed has cut its target for the Federal funds rate -- at which banks lend to one another overnight -- three times by a full percentage point. But at no time was it willing to say it was more worried about the weakening economy than inflation, a reflection of the stubbornness of price pressures, emanating in particular from energy costs.
But by earlier this month weakening employment, retail sales and manufacturing activity convinced Dr Bernanke that the risks to the economy were paramount. In a January 10 speech he promised "substantive" action, widely read as a promise to cut rates further. Many in the markets expected a cut shortly at that time. Some Fed officials saw merit in the idea.
Dr Bernanke thought it better to act at next week's scheduled meeting, but market events forced his hand. Last week, bond insurers faced the threat of rating downgrades that would force banks to take on billions of dollars of added default risk, and then came the global stock market plunge on Monday.
The Fed itself and markets were closed for the Martin Luther King Jr holiday, but Dr Bernanke - who comes into the office seven days a week - was at his desk. After consulting with Federal Reserve Bank of New York president Timothy Geithner and vice-chairman Donald Kohn, he convened a videoconference call of the Federal Open Market Committee (FOMC). Since economic fundamentals justified a significant rate cut, the main issue was convincing the committee that it should be done now. All but one of the participants, William Poole, president of the Federal Reserve Bank of St Louis, voted for the move. He did not believe conditions justified moving before the meeting, the Fed said.
The timing may resurrect accusations that the Fed is too quick to bail out investors at the expense of low inflation and prudent behaviour. And by setting aside the long-standing preference of moving only at meetings, the FOMC risks looking desperate. Vincent Reinhart, a former top staffer at the Fed who is now a scholar at the American Enterprise Institute, said the Fed might have put itself in "harm's way" by basing its action so explicitly on market developments.
"If markets go down after you've acted, do you jeopardise some of your credibility? I think they did," Mr Reinhart said. If market panic resumes, "you are then faced with the question, what is plan B?"
But former Fed governor Lyle Gramley, who now follows the Fed for Stanford Washington Group, said the risk of not acting was larger. "You have a credibility problem whenever things don't go right," he said. "You have a much larger credibility problem twiddling your thumbs, doing nothing, when the economy is going down the tubes."
Before announcing the rate cut on Tuesday, the Fed notified its counterparts in Japan, Britain, Canada and the European Central Bank. By the end of the day, only the Bank of Canada had followed suit, lowering its short-term rate a quarter of a percentage point at a scheduled meeting, as expected. But the governor of the Bank of England suggested rate cuts in the UK were likely, and markets anticipate that the European Central Bank - despite its tough rhetoric about inflation worries - will follow later this year.
The Fed said it acted because of a "weakening of the economic outlook and increasing downside risks to growth. Broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labour markets".
The Fed also said it expected "inflation to moderate in coming quarters", though it would "monitor inflation developments carefully".
Typically, lower interest rates begin to help revive a sagging economy by spurring purchases and construction of homes. But the deflating real estate boom had left an unprecedented share of homes standing unsold and vacant, said Columbia Business School economist Christopher Mayer, suggesting the moves may have less effect than usual. "No matter how much the Fed cuts interest rates we are not going to see an appreciable pick-up in home construction for a couple of years," he said.
Lou Barnes, president of Boulder West, a mortgage bank in Colorado, said the cuts would help only those home buyers who qualified for prime mortgages of $US417,000 or less. Banks that used to originate mortgages for less than perfect credits, or for amounts above $US417,000, were reluctant to do so because they could not sell them to investors and had little room left on their own balance sheets for them. (Mortgage giants Fannie Mae and Freddie Mac cannot buy mortgages above $US417,000.)
Tuesday's move came closer to the day of a scheduled meeting than any between-meetings move since the Fed began announcing rate changes in 1994. The Fed last cut the target for the Federal funds rate in one move by as much as three-quarters of a point back in 1982, when it was lowered a full point.
Additional reporting: Sudeep Reddy, Timothy Aeppel, Conor Dougherty and Justin Lahart
US rate move prompts $60bn surge
ReplyDeleteBy Michael Sainsbury and Glenda Korporaal
EXPERTS warn that continuing weakness in the US economy and share market will hold back Australia for some time, despite yesterday's $60 billion surge in the local share market resulting from the surprise rate cut by the US Federal Reserve.
Trevor Rowe, an investment banker who chairs the Queensland Investment Corp, said: "Until we see some good economic news out of the US, we won't see a sustainable recovery in the market."
He also noted that a lot of hedge funds had been shorting the Australian share market, forcing prices down sharply.
In early trading the major Australian indices jumped by almost 7 per cent or 350 points, one of the biggest intraday jumps ever, and enough to prompt some analysts to say the worst of the shake-out had passed.
The unwelcome arrival of a high quarterly inflation figure cast a long shadow, however, and the All Ordinaries index lost ground later to close 223.6 points higher at 5445.6, up 4.35 per cent for the day.
The core annual inflation number of 3.6 per cent, announced in Canberra at 11.30am, reflected a quarterly rise of 0.9 per cent.
Since the Reserve Bank's limit for manageable annual inflation is 3 per cent, hopes of interest rates staying steady after the bank's next meeting, on February 5, took a battering.
The futures market, which last week reduced the expectation of the official interest rate rise from 40 per cent to 16 per cent, switched direction sharply, estimating a 46 per cent probability that the bank would raise its 6.75 per cent cash rate to 7 per cent.
This is despite the US Federal Reserve's emergency step of cutting its official Funds rate to 3.5 per cent from 4.25 per cent, with strong indications that another cut could follow before the end of the month.
The local market's jump was a relief after falls of 4 per cent and then 7 per cent over the previous two days, the latter the biggest one-day fall in two decades.
Blue chip stocks led the way, with BHP and Rio gaining $2.89 and $5.01 respectively, while Wesfarmers (up $2.60), Telstra (up 27c) and three of the four major banks recorded strong gains.
Only NAB faltered on afternoon rumours of exposure to ailing finance group Allco.
The return to positive territory closed an unprecedented run of negative days on the local market -- 12 in a row.
The emergency cut by the US Federal Reserve was partly triggered by shock drops in Asian and Australian stock markets yesterday and fears of a US recession, which wiped $110 billion from the Australian market alone.
Many players were privately unsure which way the market would go next.
"I can't see we are going to get out of this in a hurry," a senior funds manager said.
"It is hard to see how the entrepreneurial stocks are going to get through this without some difficulty.
"NAB fell 10 per cent in a matter of minutes before it rebounded. It shows the market is pretty nervous.
"Some of the entrepreneurial stocks will go the way of the entrepreneurial stocks of the 1980s. Those guys' days are over.
"There are still problems but you don't know where the problems are."
A number of veterans were more bullish, convinced the market fall had been overdone.
Former Adelaide Steamship chief John Spalvins, who is still an active private investor, said the local market had been oversold.
"The Australian economy is in great shape," Mr Spalvins said.
"The unemployment rate is low. Our inflation is under control and our interest rates are lower than they were in 1987, 1988 and 1989. Commodity prices are booming."
Entrepreneurial stocks and companies with large borrowings might not fare well because of the tougher credit market, but resource stocks such as Rio and BHP Billiton were good buying at the moment, he said.
"It is difficult to understand why the Australian market should have been down by 24 per cent from its peak when the US market was down only 10 per cent.
"It is irrational, driven by fear. It is bound to bounce back.
"It is only a question of when that will happen - whether it is a day, a month or half a year.
"In a year people will be looking back and asking why they didn't buy."
Goldman Sachs JB Were Australia chairman Terry Campbell said Tuesday was probably the lowest point of the plunge. "We have now had a decent correction from where the market was in August," Mr Campbell said.
"The recovery after the downturn in August didn't make sense because the credit crisis was obviously so serious.
"The market is now down 15 per cent from mid-year, which is not a bad pull-back from a speculative high."
It was time people started looking at the prices of stocks and returned to some selective buying, Mr Campbell said.
"There's a lot of cash around and we are probably reasonably close to seeing the full impact of the margin calls," he said.
"Valuations are starting to look reasonable and earnings - even allowing for the fact that they are not going to be up as much as analysts thought - should still show improvement."