Rate Rise Looks Certain After Inflation Hits Six-year High

The Age

Tuesday March 4, 2008

Vanessa Burrow, Markets Reporter with AAP

INFLATION data released on the eve of today's Reserve Bank board strengthens the chance of an interest rate rise in May to follow an expected announcement this afternoon of a rise in the cash rate from 7% to 7.25%.

Inflation powered to a six-year high in the 12 months to February 29, according to the TD Securities-Melbourne Institute Monthly Inflation Gauge.

The gauge showed a rise of 0.3% in February, which took annual headline inflation to 4%. Underlying inflation, which excludes one-off price increases and decreases, rose to a record 4.1%.

Analysts said that if Australian Bureau of Statistics' measures of inflation squared with the TD Securities gauges, the Reserve Bank would be left with little choice but to ratchet rates up further.

"For inflation to move lower and eventually fall within the RBA's target band (of between 2% and 3%), further monetary policy tightening is required," said TD Securities senior strategist Joshua Williams.

The TD Securities data showed the main contributors to inflation in February were price rises for rental accommodation, vegetables and financial services. They were partially offset by falls in the prices of automotive fuel, holiday travel and accommodation, and fruit.

As well, ABS figures on company profit results, released yesterday, indicated the economy would post an annual growth rate of close to 4%.

Company gross operating profits at current prices climbed 3.9% during the December quarter, seasonally adjusted, the ABS reported.

This was almost double market forecasts of a 2% rise.

The construction sector posted the strongest quarterly profit jump of 13.7%, with property and business services runner-up on 10.1%.

Transport and storage was the only segment to post a negative result, with profits down 5.6% in the three months to December 31, as petrol prices increased.

Across all sectors profits were up 11.7% over calendar 2007, but the result was distorted by the inclusion of a fully privatised Telstra after the March quarter of 2007.

Meanwhile, estimated business inventories rose by 0.7% in the three months to December, coming in marginally below forecasts of 1% growth.

Inventories made annual gains of 4%.

Interest rate expectations, however, failed to hold up the Australian dollar. It fell more than US2? as equity markets tumbled and flight-to-safety investments such as gold soared.

The rise in the Reserve Bank's cash rate to 7.25% will stretch the gap between Australian rates and US rates to 4.25 percentage points. This huge yield differential would usually be a plus for the Aussie, but HiFX Foreign Currency Exchange trading director Mike Hollows said market volatility had halted the currency's progress.

"It's a direct flow on," he said. "But it's as strong as 10 men when you look at it against the $US dollar."

In the past two trading days, the dollar has fallen from a 24-year high of US94.98? to a low of US92.79?. Last night it was buying about US93.3?.

Mr Hollows said the dollar had also fallen about 4% against the low-yielding yen as investors' risk appetite declined and the Japanese repatriated their profits before the March 31 end of financial year.

All 30 members of the Dow Jones Industrial Average fell on Friday, as weak US economic data combined with more write-downs on mortgage-backed securities and a hitch in the a rescue plan for bond insurer Ambac.

In Australia, the S&P/ASX 200 Index lost 166.3 points, or 3%, to 5405.8 - the lowest close in more than a month.

Again the banks dragged the market down, with the Big Four alone accounting for a quarter of the market's fall.

AMP sank 69?, or 8.6%, to $7.36 and QBE Insurance fell $1.37, or 6.1%, to $21.20 while Allco Finance Group fell a further 25?, or 28.7%, to 62?.

Credit Suisse equity strategist Adnan Kucukalic said financials had become a perilous area for investors. Money had become a rare and expensive commodity and banks were having to pay much higher interest rates, he said.

However, Mr Kucukalic said most retail and investment banks had lost a third of their value in a couple of months and were starting to look like good value.

He also said commodities, which had fuelled the Australian dollar's rise, had become a defensive asset class, proving attractive to investors while equity markets were skittish.

Gold has sprinted to within touching distance of $US1000 an ounce, selling for as much as $US984.42 an ounce yesterday.

Oil remains above $US100 a barrel, with West Texas intermediate crude selling for $101.84. -- With AAP

© 2008 The Age

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