Mixed signals

by David Taylor


You could be forgiven for being a little confused about the state of the Australian economy at present. Figuring out the international macroeconomic environment is arguably even harder. Let's try and simplify things a little.


Looking at Australia, it's clear we have what's called a 'two speed economy'. That is, while the resources sector is powering ahead - led by an economic boom in China, the Australian consumer is clearly at drag on economic growth (retail sales yesterday came in at -0.5 per cent). But with higher utilities, petrol, and fruit and vegie prices, there is also short term upwards pressure on inflation. In fact the labour market is also tight which means wages pressure is also adding to inflation.


It leaves the Reserve Bank in a bit of a tight spot. If they raise rates too early, they could bring the consumer to its knees and well as provide a serious blow to the already struggling property market. Alternatively, if they hold on, inflation could spiral well outside the Bank's comfort range and disable the broader economy.


They key is thinking strategically. That is, we need to know what current forces in the economy are short term and which are long term? The RBA is currently banking on the fact that the short term negative effects of the recent Queensland floods and cyclone Yasi (higher prices and lower growth) will pass and that the ongoing mining boom and pressure on wages will leave it with no choice but to hike rates. If they get it wrong on China, you can bet that the first quarter of this year will not be the only quarter with negative economic growth.


As far as the world economy is concerned...as predicted...we are now fighting the inflation monster. You simply can't print so much money, and have such easy monetary conditions, and not expect to see inflation pressures. There's really too much liquidity circulating at present.


With more Euro zone countries asking for financial assistance, Japan virtually on its knees, China struggling to contain a property bubble and runaway inflation, and US unemployment read proving all too stubborn, once monetary settings start to tighten, conditions are expected to get more uncomfortable.


The reason why interest rates at zero and printing money seems like the easy option is that it is. The result should be higher growth and higher inflation - some would say difficult to manage. What we're seeing now is slightly elevated growth with signs of rising inflation - some would say much more difficult to manage.


For both the domestic and international economy, it's a race between growth and inflation. We just can't afford inflation to win.


Keep watching the commodities markets too. That's where the big money flows are. Those markets are capturing the sentiment/confidence narrative at the international macroeconomic level. The decline in commodities prices (especially oil) this week says markets are getting nervous about the state of the US economy.


David Taylor


The content in my blog is non advisory, please do not interpret this as advice in any way shape or form. These are just my thoughts and nothing I say should be acted upon.

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