Wednesday, July 25, 2007

CPI, The Reserve Bank and Interest Rates

Today's release of the June-07 Quarter CPI figures has had mixed reception.

The Treasurer, Peter Costello, chose to look backwards over the previous 12 months, and quoted a 12-month inflation figure of 2.1%. This is low, but higher than the expected 1.9% for the 12 months.

But voters, and the Reserve Bank, need to look a little deeper. The June 2007 Quarter CPI was, overall, 1.2%: it seems not much, but if that were sustained over 12 months the annual inflation rate would be about 5%, a figure that would make both the Treasuer and the Reserve Bank turn white with fear.

The graph below shows the CPI and Housing Loan interest rates since December 2005.
(Data from: Reserve Bank of Australia and Australian Bureau of Statistics)

As you can see, the fluctuations inthe Home Loan Interest Rate match very closely the changes in the CPI. When the Reserve Bank meets next week, the chart suggests that it will raise the official cash rate. Banks and other lenders will increase their interest rates.

The Reserve Bank is independent of government, but you can bet your bottom dollar the government will be trying to pressure the Reserve Bank into not raising interest rates. Based on history, it is "almost certain" to raise them; if not next week, then at the beginning of September.

If interest rates rise at all, it will be bad news for John Howard: he relies heavily on his "economic management", but homeowners are already stretched, and a rise in interest rates is not a good economic look.