May Rate Rise Likely After Inflation Hits Six-year High

The Age

Tuesday March 4, 2008

By Vanessa Burrow, Markets Reporter, with AAP

INFLATION data released on the eve of today's Reserve Bank board meeting 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%.

The data hit the market on another day of tumult, with the benchmark share index diving 3% to 5405.8 and the dollar dropping US2? to US93.4?. Gold neared $US1000 an ounce, touching $US984.42.

Analysts said that if Australian Bureau of Statistics' measures of inflation to be released in late April squared with the TD Securities gauges, it was highly likely the RBA would ratchet rates up further in May.

"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.

ABS figures on company profits, released yesterday, indicated the economy would post annual growth of close to 4%.

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

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 next 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.

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%.

The likelihood of another rate rise within two months failed to avert a sharp reversal for the dollar.

Today's expected rise in the RBA's cash rate to 7.25% will stretch the gap between Australian rates and US rates to 4.25 percentage points - a huge yield differential that would usually be a plus for the Aussie.

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 US93.1?.

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

All of the 30 stocks that make up 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 rescue plan for bond insurer Ambac.

In Australia, the S&P/ASX 200 Index lost 166.3 points, to 5405.8 - the lowest close in more than a month and only 219 points above the January 22 low.

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

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, particularly when they paid substantial fully franked dividends.

He also said commodities, which have fuelled the rise in the Australian dollar, 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

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