First we had the “recession we had to have” and soon, we may have “the interest rate increase we had to have.” Whilst businesses remain robust, it is obvious that the same can’t be said for our economy which continues to struggle. The Macquarie Research Economics report was released on Wednesday 24 October 2007 “Australian economics. CPI: An untimely wake-up call”. Analysts were Brian Redican and Annette Martins.

Impact: Underlying inflation was higher than the market had expected, and surged to the top of the Reserve Bank of Australia’s inflation target band. This should be more than enough to convince the central bank to raise interest rates at its November Board meeting. But with underlying inflation already at uncomfortably high levels and the risks to inflation firmly to the upside, will one rate hike be enough to keep price pressures under control ?

Analysis(We have abbreviated the report)

Housing – related expenses – rents, utilities and property rates- accounted for over half of the overall increase in the CPI adding 0.37ppt to the 0.7% increase in the quarter. Rents alone are rising at an annualised rate of 6.2% and if the housing market continues to get tighter, this should put further upward pressure on rents.

Food prices – predominantly fuelled by fruit and vegetables – accounted for 0.31ppt of the rise in the CPI. The pick-up in food prices have been spurred by the drought, and in turn, the lack of irrigation.

Our view on the likely path for interest rates is that apart from a 25bps rate hike in November, we also think it probable that the RBA will follow this up with another 25bps in either December or February. That said, if domestic banks decide to pass on a financial tightening (due to tighter credit conditions) to consumers, the RBA may hold-off on another monetary tightening until well into the New Year.

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