Drought will halt inflation: OECD

Rates to dip in ’07.

MODEST interest rate cuts are likely from late next year, with inflation pressures subsiding by the middle of 2007, the Organisation for Economic Co-operation and Development says in its latest economic outlook for Australia.

However, it expects economic growth will remain below trend until 2008, held back in 2007 by the effect of the drought on the agricultural sector.

“Interest rates are close to a level that should ensure inflation returns to the target over the coming year. Modest interest rate cuts from late 2007 should not jeopardise inflation stabilising around the mid-point of the target,” the OECD says.

It says a substantial improvement in Australia’s trade balance in recent months suggests a long-awaited pick-up in resource export volumes — which may have been constrained by inadequate infrastructure — is beginning to materialise.

“However, drought conditions are likely to hold back agricultural exports in 2007 and restrain growth,” it says.

Gross domestic product growth was just over 2 per cent in the year to mid-2006, well below trend growth of over 3 per cent, the OECD says.

The unemployment rate was 4.6 per cent in October.

Higher petrol prices and interest rates have dampened consumption, while a four-year business investment boom has slowed markedly.

“A recovery in the agricultural sector, assuming a return to more normal rain patterns, should lead to a pick-up in growth in 2008 to above 3.5 per cent, with the economy operating close to capacity.

“A prolongation of the current drought would endanger the pick-up in growth in 2008.”

The OECD says the Government should maintain a modest fiscal surplus as buoyant tax receipts related to the commodities boom “will be transitory”.

Substantial income tax cuts in the May Budget, as well as plans for increased spending on infrastructure by the states, are likely to see the surplus roughly halve as a share of GDP over the next two years.

Source: The Border Mail

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