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Australian poll largesse risks high rates, inflation

(SYDNEY) Generous promises from Australia’s two main political parties ahead of tomorrow’s general election have stoked fears that interest rates, already at the highest in a decade, may go up even further than the market anticipates.

Financial markets are pricing in a rate rise early next year, but analysts say investors might have to factor in more increases if the tax cuts and spending promised by the politicians boost demand and add to price pressures.

‘In the run-up to the Federal election, both political parties are running a real risk of eliminating the budget surpluses projected by the Treasury,’ said Stephen Halmarick, co- head of economics and market analysis at Citigroup here.

‘The result could be more upward pressure on inflation and rates. We already expect another rate rise from the Reserve Bank of Australia (RBA) early next year and the risks are slanted to the official cash rate going beyond the 7 per cent that markets are currently pricing.’ The central bank raised the cash rate to an 11-year high of 6.75 per cent this month.

Latest polling suggests the opposition Labor Party will be swept into office, unseating veteran conservative Prime Minister John Howard, who is hoping for a fifth term in office.

In a bid to win back voters, Mr Howard has promised A$34 billion (S$43 billion) in income tax cuts as part of some A$66 billion in election largesse. Labor’s Kevin Rudd, almost as generous, has unveiled a package worth A$59 billion, including A$31 billion in tax cuts. Both are relying on large budget surpluses as Australia rides a commodities boom.

The surplus for 2006/07 was A$17.2 billion, or about 1.6 per cent of gross domestic product (GDP), and the Treasury estimates it will total A$61.4 billion over the next four years, boosted by high revenue at a time of robust domestic growth. GDP grew 4.3 per cent in the year to June, giving 16 years of uninterrupted expansion.

But that is pushing up consumer prices. The RBA raised its forecast for annual underlying inflation to 3.25 per cent for the current quarter and up to mid-2008, up from a 3 per cent forecast.

The RBA, which aims to keep inflation in a 2 to 3 per cent band, cautioned that the economy was showing little sign of slowing despite five rate increases since May 2006, with demand remaining healthy and the jobless rate at a near-33-year low.

Some economists argue that the tax cuts and spending will not come all at once, so they might not be as inflationary as feared.

‘Many of the commitments are spread over five years,’ said Craig James, chief equities economist at CommSec. ‘It’s also important to remember that these are just spending commitments; they haven’t been made as yet, and they could be amended down the line. Further, revenue measures haven’t been announced. That’s for later.’ However, Rory Robertson, an interest rate strategist at Macquarie Bank, said the political parties’ priorities were clear.

‘Both sides of politics have agreed their priority was tax cuts and increased spending,’ he said.

Neither was ‘showing much interest in providing real support for the RBA’s efforts to slow demand growth and dampen growing inflation pressures’.


Source: Reuters (Business Times 23 Nov 07)


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