Rates in doubt as producer costs jump

RISING costs and soaring oil prices have stoked fears rates will stay higher for longer

Rates in doubt as producer costs jump

A RECORD jump in business costs has triggered a dramatic repricing of interest rate expectations, with forecasts for an easing in monetary policy by the end of 2008 sharply reduced.

The producer price index, or PPI, jumped 1.9 per cent for the March quarter, almost doubling expectations for a 1 per cent increase and lifting the annual inflation rate for business costs to 4.8 per cent.

The data saw the inter-bank cash rate futures market dramatically repriced and the chances of a rate cut by the end of the year falling from a 90 per cent chance to 20 per cent.

"The PPI report raises the possibility that rates will remain on hold for an extended period,'' St George senior markets strategist Besa Deda said yesterday.

"Financial markets had, prior to this report, factored in quite a high probability that the RBA might cut rates by the end of the year, but that probability has now fallen away quite sharply.''

Mounting building costs, a soaring oil price and a jump in demand for electricity, gas and water supplies were the main drivers behind the surge in producer prices.

The 4.8 per cent result was the largest annual rise since 2000 and the 1.9 per cent rise was the biggest quarterly move since the start of the series in 1998.

Strategists said the PPI result suggested more upward risks for tomorrow's key quarterly CPI inflation data.

ANZ revised its CPI data upwards on the back of the PPI data, putting annual headline inflation at 4.2 per cent, slightly above market expectations of 4 per cent, while the bank forecast the underlying rate to be 4 per cent.

Quarter-to-quarter correlation between the PPI and CPI had become closer in the last few years, said ANZ interest rate strategist Sally Auld, making any chance of an easing in interest rates remote.

"Some forecasters have been keen to get on the rate-cut bandwagon, but these figures are telling us that the last thing the RBA will be thinking about is rate cuts,'' Ms Auld said yesterday.

It was unlikely that the RBA would opt to hike rates in May, given the recent independent tightening in credit markets, Ms Auld said, but July would be a critical month for inflation.

"And if that shows signs of being very stubborn -- and not well behaved -- then they (the RBA) could start to consider whether they need to raise rates again,'' Ms Auld said.

Analysts said the RBA was now in a holding pattern with various cross-currents influencing the domestic economy, with tighter credit markets weighing on demand while better terms of trade boosted growth.

"The RBA just remains in a holding pattern and the data reaffirms that,'' Ms Deda said.

Despite signals by the Reserve Bank that the economy had started to slow, the dilemma for the Reserve Bank is similar to that experienced in New Zealand.

"The RBNZ was a bit like the RBA: really aggressive and four rate hikes in six months. The cash rate is at 8.25 per cent and it's been there since last year,'' Ms Auld said.

"It took nine months for the RBNZ to change its tune and be more concerned about growth and less about inflation.''

To read the Australian Bureau of Statistics report, go to http://www.theaustralian.com.au/business