Wednesday, April 25, 2007

Low Infaltion Figure, Interest Rates & the Federal Budget

Yesterday's surprise March 2007 CPI figures are expected to prevent the Reserve Bank increasing interest rates again.

The March 2007 Quarterly CPI figure 0.1%, and the inflation rate for the year to March was 2.4%. However, total figures don't always tell the whole story. The Australian Bureau of Statistics data includes a "contribution" of -0.6% for food. The main contributor was falling fruit, especially bananas. However, last week we were told to expect food prices will increase sharply this year as the drought further reduces our ability to produce enough food to meet demand.

If food prices had remained the same, the CPI would be 0.7%, and the inflation rate 3.1% for the year. If that had happened, it is almost certain the Reserve Bank would have raised interest rates next week!

Nevertheless, newspapers were full of speculation that the budget will deliver more personal income tax cuts. What effect will this have on the economy? We know there are still significant inflationary pressures from the costs of child care, health, pharmaceuticals and education. In 2005, the CPI for the quarters after the budgeted tax cuts (effective July) were 3.0% and 2.8%; in 2006 they were 3.9% and 3.3%.

Three of those four figures are at or above the Reserve Bank's "comfort level" of 3% and led to rises in interest rates.

So, what about the budget, to be delivered in May? Personal income tax cuts effective from July this year will certainly lead to increased discretionary spending and create further pressures on inflation. Peter Costello will need to exercise considerable economic prudence in whatever tax reform he indulges in the May budget: but there's an election looming and voter bribes will be order of the day.

The Analyst