Floods put inflation on doorstep

Glenn Stevens, governor of the Reserve Bank of Australia. Photo / Bloomberg

Australia's Reserve Bank Governor Glenn Stevens can glimpse the inflation threat he faces from the nation's floods at the produce shop near his suburban Sydney home.

Tomato prices soared 20 per cent in the past week and bananas, grapes and sweet potatoes are up 10 per cent, said Maurice Sorace, owner of Sylvania Best Fresh in Sylvania Waters, who gets about a third of his fruit and vegetables from flood-ravaged Queensland.

"Prices will be higher in the next week" as the deluge drowned more crops and clogged roads, he said.

The crisis may force the RBA to accept higher inflation in coming months as the floods spur food and commodity costs and slow growth in a disaster zone the size of Egypt.

Australian inflation-linked bonds rallied the most in more than five years as the damage, with future rebuilding in a country already near full employment, risked stoking consumer prices.

"At a time when the economy does not have a lot of spare capacity and a mining and energy-investment boom is also expected over the next few years, the RBA will face an even greater challenge to manage medium-term inflation pressures," said Paul Brennan, an economist at Citigroup in Sydney.

The river that bisects the Queensland state capital, Brisbane, has burst its banks, threatening thousands of properties and inundating parts of the nation's third-biggest city.

"Now the floods are urban, much greater damage to infrastructure is likely," Roland Randall, an economist at TD Securities in Singapore, said in a note to clients.

"We have pushed out our expectation for the RBA to resume tightening monetary policy to April or May" from a previous call of March, he wrote.

As the water crests, investors are increasing bets that price gains will accelerate. The extra yield of Australian inflation-linked bonds maturing in five years compared with nominal five-year Government debt - a gauge of the inflation investors expect over the period - in United States trading reached 2.98 percentage points on Wednesday, the highest since April 2007.

The cost to the nation could total as much as A$13 billion ($16.98 billion), or 1 per cent of gross domestic product, said Stephen Walters, chief economist JPMorgan Chase in Sydney, who has changed his forecast for the next rate rise to May from February.

RBA board member Warwick McKibbin said such a hit to GDP "is not out of the question", the Sydney Morning Herald reported yesterday.

The rains forced Caltex Australia, the nation's biggest oil refiner, to idle a refinery that supplies about a third of Queensland's fuel needs. The shutdown was expected to cost A$5 million to A$10 million this year, Caltex said.

Mining companies including Rio Tinto Group, BHP Billiton and Xstrata have deferred deliveries of coal, driving up the price for steelmaking and power coal. Thermal coal prices have already risen to the highest since September 2008.

Cattle prices in Australia, the second-largest beef exporter, jumped to near a record.

Stevens has a mandate to keep inflation in a range of 2 per cent to 3 per cent. In July to September, the consumer price index rose at a quarterly pace of 0.7 per cent. It may rise 1.2 per cent in the first quarter of this year, according to a Bloomberg News survey, compared with a pre-flood estimate of 0.9 per cent.

The projected pace would be the fastest since the third quarter of 2008, when the RBA's cash-rate target was at 7.25 per cent, compared with its current level of 4.75 per cent.

- BLOOMBERG