Reserve Bank of Australia Reports Inflation Is Out of Control

"This is shocking," Matthew Sharratt tells Bloomberg. He's an economist with Bank of America in London. "It feeds concerns about inflation, and will make the Bank of England cautious about lowering interest rates too rapidly."

Yes, the forces of inflation are on the march all over the world. In London, producer prices for chemicals, textiles, and food rose 5.7% from the year before. It's the fastest rate since 1991.

And that's just what producers are passing on to retailers. London's office of National Statistics reports that he cost of raw materials increased an annual 19.1 percent, the biggest jump since they began tracking such things 1986.

But the big news yesterday is how terrified the Reserve Bank is that inflation is already out of control here in Australia. The Bank lifted its forecast for inflation this year to 3.5%. And it said it that there's enough heat being generated in Australia's booming economy to make things uncomfortable until 2010.

"If demand were to be stronger than expected, the forecast easing in the inflation rate would be unlikely to eventuate with the current policy settings," the Bank said in its quarterly Statement on Monetary Policy. "Most importantly, if it is not reversed reasonably quickly, the recent pick-up in inflation carries the risk of generating an upward drift in inflation expectations, which could feed back into wage and price-setting behaviour."

Reinforcements! Judging by the futures market, investors now expect the RBA to send at least two more rate rises "over the top" and into action by the middle of the year. Glenn Stevens fears a cycle in which producers pass on rising costs to consumers, which forces up wages and accelerates spending as people race to trade cash for something more enduring.

The rate rises will be bearish for Aussie housing and perhaps not as bullish for the dollar as you might expect. The Reserve Bank is moving in the opposite direction of most of the world's major central banks. The Fed, the ECB, the Bank of England, and perhaps the Bank of Japan all have an easing basis.

"It can't be bullish if the rest of the world is bearish," our currency analyst Gabriel Andre said. "Yes, the yield difference is widening. But if the rest of the world is cutting rates to avoid recessions, then Australia's economy will be impacted by that. The rates won't be the main driver. Growth will. And even though Aussie growth is strong it's forcing rates up, no country is an island in the global economy."

Australia is, of course, an island continent. But it's connected to the global supply chain and thus not immune from what happens abroad.

The RBA report on inflation wasn't all bad news, however. We asked Diggers and Drillers editor Al Robinson if the RBA said anything about commodity prices. "Yes, they did," he replied.

"Looking at the first graph below, from the report, there's one fact that stands out. The last time global wheat inventories were this low was in the early 70's. Old-timers will remember this as the early stages of the previous big commodities bull market.

What Inventories Plunge

"Wheat prices surged soon after," Al reports. "They topped out in 1973...but this time, farmers don't look as capable of filling the gap. Droughts are causing pain, China's insatiable, and unprecedented energy demand has cut stockpiles to scary levels. I'm saddling up my bull on this one."

But wait, there's more.

"The second graph below depicts a bullish story for coal and iron. Its little wonder Xstrata just raised its bid for Australia's Resource Pacific by 12%. Within the next year, the stock could easily be sitting on contract gains of over 50%. Why would anyone buy Macquarie Bank when coal and iron stocks are cheaper than they've been for 9 months? It's sheer madness."

Coal and Iron Contract Prices

Yes. It's a mad, mad, mad, mad, mad, mad, mad world.

Dan Denning
The Daily Reckoning Australia

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