Inflation risk grows as economy steams ahead

Australia has enjoyed a record 16 years of continuous economic growth which begs the question "is it all about to end?" The bad news is that one of our major trading partners, the USA, is now considered by many to be technically in recession, which usually spells trouble for Australia.

The good news is that Australia's economic fundamentals remain strong, and ANZ's forecast is for another two years of above-trend economic growth. In fact, the key challenge will be whether growth can be sufficiently constrained to ease inflationary pressures to an acceptable level over the medium-term. This in turn has important implications for home owners and borrowers, who are already facing sustained high interest rates this year. If inflation cannot be controlled, higher interest rates become more likely.

Growth at a three-year high
Economics@ANZ's optimism reflects a number of considerations. First, although global economic growth is slowing, the slowdown has been most pronounced in developed countries. By contrast, many of our largest trading partners, particularly China, are expected to remain robust.

Secondly, although Australian financial markets have been caught up in the global market turmoil, Australian financial institutions have not recorded the large losses of some offshore banks. Hence while monetary policy is tightening, there is no sign of a "credit crunch" in Australia.

Finally, recent widespread rains are holding out the promise of a very substantial rebound in rural production over the next year. This will add to what is already a strong forecast for economic growth.

Overall, then, is it difficult to be too pessimistic about the outlook for Australia despite the global woes. ANZ estimate GDP will have been close to 4% in 2007 and forecast growth of around 3.5% in 2008 and 2009.

Inflation the key risk to home owners, borrowers
Interest rates in Australia have been rising for nearly six years, but demand for credit remains robust. The continued strong demand for credit is one reason the Reserve Bank of Australia (RBA) has acted to raise official interest rates.

The main reason, however, is inflation, which is now Australia's primary policy concern. There's no getting around it: Australia has an inflation problem. The headline consumer price index rose 3.6% in 2007 - above the RBA's 2-3% target band. With labour force participation continuing to rise and signs of an acceleration in wages growth, the inflation problem is unlikely to ease in the short-term.

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How to minimise the impact of rising rates

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