Beware the good cop/bad cop routine that we think is being played by central characters at Australia's Reserve Bank.
The Governor, Ian Macfarlane, has played the role of the good cop. He has been encouraging thinking that the big US current account deficit is the "fault" of Asian countries saving too much or investing too little (see chart), which has depressed global interest rates. As Asia and oil producers will continue to save too much in the near-term, financial markets, ever willing to look on the bright side, have revelled in this comparatively calming view.
His story within this bigger picture, though, is more pertinent. On the one hand, he has argued that the recent heights achieved by oil prices will not significantly slow the global economy or raise global inflation.
Thankfully, on the other hand, he has also pointed out that some of the unusual factors that have kept global real and nominal interest rates at such very low levels are beginning to unwind. In particular he named the continuing removal of monetary accommodation in the US and the first steps by China towards currency flexibility as factors that will eventually raise global real interest rates.
We certainly agree with the RBA governor that, internationally, good news far outweighs bad news. Despite - or even because of - the clean-up following hurricanes Katrina and Rita, the US is showing continued prospects of firm growth, though with prospects for longer-term inflation now only "contained", rather than "well contained".
China still booms. Japan's recovery is in train and may surprise on the high side, while Korea's growth resumption is encouraging. Euroland is growing only slowly, but there has to be an exception to the "stronger-for-longer" growth story.
We also agree that, after the US Fed's last interest rate hike, it sees its funds rate - 3.75 per cent - as too low. We envisage the funds rate will be 4.5 per cent by mid-2006, after Mr Greenspan retires next January. The role of bad cop falls to the governor's deputy Glenn Stevens. He is speaking next Tuesday to business in a Tasmanian casino.
In this tag-team act, he will have to take the strong global growth from Mr Macfarlane's speech and discuss the Australian implications.
He is likely to find Australia's labour market tight (notwithstanding job vacancies fading), wage growth is edging up (especially to attract city folk to mining) and productivity is edging lower. Not enough spare capacity has been created by the housing sector slowdown, and the economy overall is reviving.
The exchange rate has also weakened as the US has raised interest rates, at the margin adding to import costs. These factors are beginning to raise the core rate of inflation. Worryingly, as all motorists are too aware, high oil prices are also raising the headline rate of inflation.
In a move that should give special impetus to his concerns, the TD Securities Melbourne Institute monthly index of inflation shot up to 3.4 per cent in September, above the ceiling of the 2-3 per cent target range for the annual increase in consumer prices set by agreement between the Treasurer and the RBA governor.
Mr Stevens is going to have to be as brutally honest as he can be about the problem. Oil price rises have been sustained for too long, and are now inevitably creeping into second round effects. Our central bank can hardly hide behind the hope that oil prices will soon fall, as such "forecasts" in the recent past have been very wrong. Oil supply is easily disrupted while oil demand seems set to remain strong. Instead he has to go with what is priced into the financial market for oil, which is high cost through 2006.
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