Inflation dragon stirs

Escalation of violence in the Middle East has been the big issue over the past month. This pushed the price of oil perilously close to $US80 a barrel, although there has been some subsequent slight easing. Events there are horrible enough but could become much worse.

The Australian economy continues to "power on", to repeat the theme of the previous article in this series. The fresh news was the shocking growth of producer prices in the June quarter and then the correspondingly bad result for consumer prices.

Monetary policy needs to be tightened further and probably will be this month. How many more rate hikes will be needed is the crucial question.

The accompanying graph provides important perspective. It tracks US and Australian consumer inflation since 1950.

The general similarity of the two series illustrates that inflation is a global disease. In the late 1960s, US inflation led inflation up everywhere. The Whitlam Government added its own inflation, and Australia quickly became a tragic economic disaster zone.

US inflation was cut earlier and more decisively than Australian inflation, but both came down to a low point in the past half decade.

Inflation has been rising in Australia and the US for several years and there is an obvious danger that this trend will persist and get worse.

Looking first at the international scene, China's too-strong, second-quarter growth (estimated at an annual rate of 11.3 per cent) and signs of domestic inflation were followed by the announcement of further monetary policy tightening.

Japan's recovery was confirmed and the Bank of Japan lifted interest rates from the zero levels that have prevailed for many years.

The US economy showed some signs of slowing, especially from the unusually high first-quarter outcome, but the US Fed continued to tighten US monetary policy.

Chairman Ben Bernanke's latest statement on monetary policy, however, contained some soothing words to the effect that, notwithstanding inflation higher than earlier expected, "the anticipated moderation in economic growth now seems to be under way", as evidenced by the slowdown in consumer spending and weakness in the housing market.