Increasing wages, prices tipped to force rate rise

INCREASING wages and prices are likely to force the Reserve Bank board to lift interest rates this year, a Deloitte report says.

Reserve bank

A RARE "tug of war" is threatening to rob the Australian economy of the solid growth it should be experiencing on the back of the mining boom, a key forecaster has reported.

In a paper released today, Deloitte Access Economics partner Chris Richardson says that accelerating wages and prices are likely to compel the Reserve Bank board to lift interest rates, even before the end of the year, in a bid to stifle runaway inflation.

While an interest rate rise is unlikely "in the next few months", Mr Richardson forecasts one will be on its way soon after.

Separately, JPMorgan chief economist Stephen Walter said interest rates needed to rise at least 25 basis points in August and the same again in November.

"If the Reserve does nothing this year and waits for wages pressure to intensify, then it will have to lift rates aggressively and that will cause more damage," Mr Walter said. "It would be prudent for them to put rates up before then."

The Deloitte report acknowledged that the central bank was "damned if it did and damned if it didn't" lift rates.

Increasing rates too soon would further damage industries that are struggling against the high Australian dollar and consumer reluctance to spend.

"Accordingly, there is a risk that 2011 and 2012 will throw up disappointing growth rates at below Australia's longer term average," Mr Richardson said.

"After all, consumers are cautious, 'savings' is the new black as Generation Y realises they haven't saved nearly enough for their burgeoning family responsibilities, while all generations are feeling the sting of higher interest rates."

Mr Richardson told BusinessDaily "the world was dropping a lot of money on Australia" through higher prices being paid for our coal, wheat and other commodities.

"But we don't have the people power to react to that demand for growth," he said. "Skills shortages in the booming industries, price increases in electricity, gas and rents should not be a reason to lift interest rates, but that is the only lever the Reserve Bank has to manage inflation."

The report said that with Australia's population growth rapidly slowing, it will be increasingly difficult to supply labour into the booming mining, engineering and construction sectors.

"This means that the latter sectors provide only a relatively small boost to the economy's overall rate of growth."

As these latter sectors are big employers, if they stay stuck in first gear then it is hard for the economy as a whole to travel too fast, the report said.