Carbon tax a mere hiccup, economically speaking

THE federal opposition's scare campaign against the carbon tax has failed its first test. The Bureau of Statistics reports that seasonally adjusted employment rose by 14,000 in July the month the tax took effect while unemployment fell to 5.2 per cent.

For the government, it was a double bonus after the TD Securities-Melbourne Institute monthly inflation gauge reported on Monday that inflation rose just 0.2 per cent in July, and was flat over the past three months.

While this was only the first test of the carbon tax, if the duo of rising employment and low inflation continues, it could have huge political implications undermining Opposition Leader Tony Abbott's repeated claim that the carbon tax would be "like a wrecking ball through our economy".

Mr Abbott yesterday stuck to his claim, pointing out that jobs rose only half as much in July as they had fallen in June. "Make no mistake, this is a python squeeze on our economy, and as time goes by it will squeeze families' cost of living, it will squeeze employment in this country," he said.

But Treasurer Wayne Swan was quick to claim vindication.

"It is yet more evidence that Tony Abbott's scare campaign on the carbon price and the mining tax is absolute baloney," he said. "Today's figures are the latest proof that he is deliberately misleading Australians and talking our economy down."

With the election not due for another year or more, the real test of the tax's impact on jobs and inflation lies ahead. But if the economy thrives over the coming year despite the tax as most forecasters expect it could become the political "game-changer" Labor is hoping for, discrediting the Coalition and its leader.

The bureau's preferred trend figures, however, paint a bleaker picture, which, if sustained, could give the debate to the Coalition. The trend data, which smooths out the ups and downs of monthly figures, estimates that job growth slowed to just 24,000 over the past three months, down from 42,000 over the previous three.

Forward indicators for employment are sending warning bells. The bureau's measure of job vacancies shrank by 15,000 in the 15 months to May.

Most of that decline was in Victoria, and mostly in white-collar jobs in professional offices, administration and healthcare.

Yesterday the SEEK index reported online job ads down 5 per cent last month and 11 per cent over the past year. The rival ANZ series was slightly less bleak, but it reported that job ads, online and in newspapers, shrank by 1800 last month and by 18,500, or 10 per cent, since February last year.

In trend terms, the bureau estimates that jobs have grown by 74,000 this year, or 10,000 a month. Only a third of the growth has been in full-time jobs. But the adult population is estimated to have grown by 136,000 in that time. Of the other 62,000, in net terms, the bureau estimates just 5000 more are unemployed, whereas 57,000 more have settled on the sidelines, not looking for work.

The jobs figures show Australia is still deeply divided between boom and bust, with Western Australia at one extreme, Tasmania at the other, and Victoria and NSW somewhere in the middle.

Western Australia is way out in front of any other state, adding 50,000 full-time jobs in the past year and cutting trend unemployment to 3.6 per cent. NSW takes the silver medal, but a long way behind, adding 20,000 full-time jobs in the year to July, with unemployment down to 5.1 per cent.

Victoria and Queensland were fighting out for the bronze. In Victoria, the bureau estimates, full-time jobs shrank by 23,000 in the year, but part-time jobs grew by 42,000. The state's unemployment rate was 5.4 per cent last month, down one notch from June.

Queensland, by contrast, added 4000 full-time jobs in the year while losing 10,000 part-time jobs. Its unemployment rate stayed at 5.6 per cent.

South Australia and Tasmania were clearly going backwards. On the bureau's figures, South Australia lost 18,000 full-time jobs in the past year one in 30 with unemployment up to 5.7 per cent. It now has fewer full-time jobs than it had before the GFC. Tasmania is in even worse trouble, losing 6800 full-time jobs in the past year, or more than one in 25.

Most forecasters still expect unemployment to edge up in coming months, if only slightly, with the Reserve Bank likely to deliver another interest rate cut this year.

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Reserve wrong and must move on

THE Reserve Bank wanted low inflation. Now it's got it. Strip away the statistical static, and for the last three quarters, underlying inflation has been running at 1.8 per cent, the lowest level for almost 50 years.

But in 1963-64 we had the best of both worlds: inflation of 0.9 per cent and growth of 7 per cent. Now we have growth of just 2.5 per cent, and most of it in outback mines. The 80 per cent of the economy not driven by mining is treading water.

This is not what the Reserve forecast. It thought the economy would be booming, and inflation around the top of its target band of 2 to 3 per cent. Instead, mining is booming, the rest of the economy is flat, and since mid-2011, underlying inflation is below the bottom of its target band.

The Reserve made a mess of it. It kept overestimating growth. It kept overestimating inflation. It raised interest rates far too high, and has kept them too high. It has no more excuses. It must now fix the problems it created.

Next week it has two choices. It can cut its losses, fix the problem quickly, and move on to the next page. That means cutting interest rates by at least 0.5 percentage points now, and by more ahead if the economy continues to underperform.

Or, if its priority is to preserve its pride, it could make just the usual cut, of 0.25 percentage points, and go on issuing rosy forecasts as if nothing had gone wrong. That would be irresponsible, but not unlikely.

The economy needs a decisive lift; a small rate cut will not give it. Mortgage rates are now at 2005 levels, appropriate for an economy growing fast. Small business overdraft rates are at late 2007 levels, appropriate for an economy overheating. Now we are slow, and cold. Even a 0.5 percentage point cut assuming the banks pass it on would still leave rates too high.

We've now had three quarters of inflation data since the Bureau of Statistics updated its index weights to reflect actual household spending. In that time, in annualised terms, headline inflation has grown at 0.9 per cent; seasonally adjusted inflation at 0.7 per cent; and underlying inflation (the trimmed mean) at 1.8 per cent.

There were times in the '90s when inflation got as low as that, but only because the index was then dominated by mortgages, so rate cuts also cut inflation. This time prices have been flattened by three things: falling fruit and vegetable prices, the high dollar cutting import prices, and the weak economy cutting retail margins.

Yes, say inflation hawks, but look at the prices of non-tradeable items: up 1 per cent in the March quarter, 3.6 per cent in a year. The Reserve can't relax its grip, because if the dollar falls, these will drag inflation back up.

Relax, hawks. The March-quarter figure is high because it includes the annual rises for health and education fees. The annual data matters. But it shows six items created 80 per cent of net price rises in the past year and not one is an area where prices are sensitive to interest rates.

The six are rents (up 4.4 per cent in the past year), health and medical services (5.1), petrol (5.9), electricity (9.9), private school fees (6.0), and cigarettes (6.3). High interest rates did not stop these prices soaring in 2007-08, or in 2011-12. If you stop to think about why, the reasons should be obvious.

The Reserve has run out of excuses. It was wrong. It needs to cut its losses and move on.

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The CPI is not a credible basis for policy action

TOMORROW the Reserve Bank board will decide whether to raise Australia's interest rates, lower them, or leave them unchanged. The consensus among economists and markets is that it will leave them unchanged. You hope they're right but it's not certain.

There is no data the Reserve focuses on more than the consumer price index. Its job is to keep inflation low, and the economy growing. The CPI measures whether or not it is succeeding. If inflation starts climbing too fast, it signals that interest rates need to rise.

Last week's CPI figures seemed to send that signal. The CPI climbed 0.9 per cent in the June quarter, and 3.6 per cent in the year to June well above the Reserve's target to keep inflation, on average, between 2 and 3 per cent over the long term.

Banana prices had a bit to do with that. But what really mattered was that the Reserve's measures of underlying inflation rose 0.9 per cent in the June quarter, after similar rises in March. The annual growth in underlying inflation was within the target range, at 2.7 per cent, but in the first half of 2011 it grew at an annualised 3.5 per cent again, well above the target.

Bankers Trust chief economist Chris Caton summed it up well. If this was the only data you had on the economy, he said, the Reserve would have a clear-cut case to raise interest rates. But it is not the only data we have. And the closer you look at it, the less clear-cut the case is.

The other data tells us that the economy is in a weak condition, outside mining and mining investment. That means the surge in underlying inflation is more likely to be a passing blip a rebound from very low rises in 2010 than the start of a dangerous rise.

A close look at the inflation data confirms this. The weightings given to items in the CPI are based on an old survey of household spending. But the Australian Bureau of Statistics changes them to reflect price rises and falls, assuming that we keep buying the same quantities of goods regardless of price changes. That defies reality, and over time, creates a bias that overstates the inflation rate, as the index increases the weight of items that rise in price, and decreases the weight of items with falling prices.

(We leave aside the third reason to be wary of pulling the interest rate trigger: the slowing global economy, and the serious risks facing it as a result of the prolonged budget standoff in Washington, and inevitable debt defaults by governments in Europe. This is no time for crazy braves.)

What do we know about the economy that should make the Reserve sit and watch for now? Plenty. The strength is largely confined to mining and mining construction. Weakness has now engulfed most of the economy. The broader-based the indicator, the clearer it is.

Jobs growth has slowed to a virtual halt. Even on the smoothed trend figures, the bureau estimates that Australia added just 38,000 jobs in the first half of 2011, compared with 188,000 in the second half of 2010.

There is no light on the horizon. The ANZ job advertisements index says job ads have been shrinking since April. The bureau's employer surveys report job vacancies shrinking since February.

The Reserve's own figures show credit growth has fallen to recession levels. In the first half of 2011, credit basically, the amount we owe the banks rose at an annualised rate of just 3 per cent. Even borrowing for housing is growing at just 5 per cent. Borrowing by business is flat.

Consumer confidence has fallen back to GFC levels. Business confidence is below sea level. In this environment, you need a very, very good reason to raise interest rates and the CPI is not it.

It shows inflation is low in most of its 90 sectors of consumer spending. In the year to June, a third recorded falling prices, a third recorded rises within or below the target, and a third recorded price rises above 3 per cent.

It is a similar story even in the first half of 2011. The unweighted median price rise of those 90 items was well inside the Reserve's target zone. But the weighted median was outside it, partly because the index over time overstates our spending on items with rising prices, and understates spending on those with falling prices.

Take bananas and computers. When this series began in 2005, fruit and vegetables comprised 2.1 per cent of our spending, and computers 1.5 per cent. But fruit and vegetable prices have soared since cyclone Yasi, while computers now pack far more power than in 2005.

But the bureau assumes we still buy just as many bananas, even at $12 a kilo, and buy 2005-strength PCs very cheap. So the CPI is estimated on the basis that fruit and vegetables now comprise 3 per cent of our spending, and computers just 0.5 per cent. And that is wrong.

Likewise the CPI seriously overstates our spending on tobacco, and understates spending on mobile phones. And when the weights are wrong, that means the data itself is also wrong.

The Reserve faces a tough call. But it must not jump at shadows. This is a weak economy; it has time to wait. The next CPI figures will be based on a 2009-10 survey of household spending. That will restore the CPI as a credible basis for policy action.

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Relief all round at signs rate pause will last

THE nation breathed a huge sigh of relief at 11.31am yesterday. It came from home owners, from the Labor Party, even from the Reserve Bank offices in Sydney.

The unexpectedly low inflation figures for the June quarter meant home owners were spared another $50 a month on their mortgage bills. The government was spared the problem of having to explain another interest rate rise to angry voters. And the Reserve was spared the unpleasant task of lifting rates in the middle of an election campaign.

Underlying inflation is now clearly within its target zone of 2-3 per cent, and has fallen to its lowest level for three years. The question now is whether it will stay there. Discounting has clearly played a big part. Weak demand in the retail economy is not only holding prices down, but actually pushing them down.

Of 90 sub-categories the Bureau of Statistics uses to calculate its index, 33 recorded falling prices in the past 12 months, including audio-visual and computing equipment (down 8.3 per cent), almost all types of clothing, as well as holiday travel, almost half the food groups, household supplies and phone bills.

Then why is headline inflation up 3.1 per cent? It comes overwhelmingly from just seven areas:

The rise in tobacco taxes, which affects only smokers.

Rising electricity charges, as growing demand collides with years of underinvestment.

Soaring house prices.

Rising petrol prices, reflecting global trends.

Higher bank margins, due to lack of competition.

Higher rents, due to too little housing construction where renters want to live.

Higher medical bills.

Those areas cover roughly half of household spending. In the other half, inflation was negligible. And that is the half that relies most on our discretionary spending.

Most market economists yesterday seemed confident that inflation will rebound soon, and force the Reserve's hand on rate rises. But then, they were wrong yesterday.

The reality is that inflation will stay low as long as households' discretionary spending remains constrained. There is no sign of that ending.

The fiscal stimulus that has propped up the economy for 18 months is winding down. Global commodity prices are coming off their peaks, reducing export income ahead. And the Reserve's six rate rises since October have yet to fully impact on consumer demand.

This rate pause could last quite a while.

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Interest rate rise looms as wild card in election battle

AUSTRALIA'S market economists believe the Reserve Bank could have to raise interest rates next month in the middle of the election campaign, with new inflation figures likely to exceed its forecasts.

On Tuesday, the Reserve forecast that next week's inflation figures will show that underlying inflation fell below 3 per cent in the year to June, falling within its target range for the first time in three years.

But the minutes of the Reserve's July board meeting hinted that if underlying inflation tops 3 per cent, the August meeting would have to consider whether the new figures "materially changed the medium-term outlook for inflation" — and if so, raise rates.

Yesterday, a Reuters survey of 20 financial houses found most think underlying inflation will top 3 per cent on both the measures by which the Reserve has traditionally defined it.

Westpac, Goldman Sachs and UBS are forecasting an average reading of 3.1 per cent, slightly up from the previous quarter. Unless financial markets are in turmoil, that would probably force the Reserve's hand.

But traders from the same financial houses clearly disagree with their economists. The ASX target rate tracker puts the chance of an August rate rise at only 27 per cent. Traders expect the next rate rise is a year away.

The Reserve will also be influenced by global financial markets' reaction to the long-awaited results of stress tests on Europe's main banks, which were released last night.

If the reports fail to satisfy concerns about the banks or the stress test process, analysts warn they have the potential to send a new wave of fear through the global financial system, slowing lending and driving up wholesale interest rates.

The Bureau of Statistics yesterday estimated that soaring coal and iron prices pushed the average price Australia receives for its exports up 16 per cent in the June quarter, the sharpest rise since figures began in 1974.

But import prices rose only 1.9 per cent, with more than a third coming from higher petrol prices. That will have little impact on underlying inflation, or the risk of a rate rise.

On a rough measure, that implies Australia's terms of trade — the amount we get paid for our exports, relative to what we pay for imports — shot up 14 per cent in a single quarter, to be near record levels.

With China putting the brakes on its economy, however, coal and iron ore prices are forecast to fall.

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