Yes the economy continued to slow in May, although retail sales lurched upwards as some retailers tried to clear stocks.

But housing approvals plunged and continue to look soft, supporting the 17 year low for housing credit in the May figures from the Reserve Bank, and Monday’s figures for a 5%-plus fall in new home sales, also in May.

As the Reserve Bank suggested in its post-decision statement on Tuesday, it’s no longer that the economy appears to be slowing; it is, and the question now is how quickly and how low, and what will be the impact of the enormous surge in oil prices these past two months?

Oil prices have jumped more than 40% so far this year, hitting a high of $US143.99 a barrel, with forecasts around of $US150 a barrel.

That was yesterday: oil surged further, hitting $US144.13 in after hours trading. It had earlier closed the official trading session at $143.57. Copper, gold, wheat, corn and other commodities were higher.

The US dollar fell sharply against the euro ahead of the ECB decision tonight.

Global inflation is running at 4.7% at the moment on a headline basis, and we will reach that this quarter according to some economists, but the Reserve Bank now acknowledges that there’s no longer any need for more interest rate rises to quell inflation.

The surge in oil prices will do that and effectively operate as a series of extra rate rises as it slowly dampens demand and forces inflation to slow.

This is something investors will have to factor in. We, like the US, Britain, parts of Europe and other western economies, are going to see an ‘earnings recession’.

The second half reports for June 30 balancing companies will be tough going for many companies and investors; the first half of the current financial year to December 31, will be even grimmer for those in retailing, property and building services.

Financial stocks will be miserable: the property slump still has the potential to cause more damage, especially in residential and retailing sectors.

Resources will do well but in reality it will be those active in iron ore, coal, oil and gas (coal seam methane). Hard rock miners in copper, lead and zinc will be doing it tough, as will aluminium and related sectors.

Energy costs are going to cause plenty of headaches for every company, and the value of the Australian dollar won’t ease for some time, unless there’s a significant downturn in activity if China sneezes.

But for an economy like Australia, it will also continue to feed through into rising export prices, further boosting our terms of trade already lifted by higher iron ore and coal prices.

But the tenor of the RBA’s statement on Tuesday now makes it quite clear that inflation, interest rates and oil (fuel) prices are all in the same mix: dangerous to the economy, but the three things that will gradually slow the pace of growth.

That’s not unless oil prices rise so quickly as to cause an almightily jolt upwards to inflation that forced the RBA to try and crush it with a huge rate rise.

The retail sales and building approvals figures for May confirmed that the sluggish economy continues to slow, although there was the perk up in retailing.

According to the Australian Bureau of Statistics, building approvals weakened again: April’s surge in non dwelling approvals disappeared and total approvals dropped a steep 6.5% to be up just 0.2% on May of last year. House approvals fell 1.2% in the month and other dwellings (flats and home units) dropped 18.2% in May from April, which was up a revised 5.4% from March.

That’s why the Housing Industry Association reported a 5.3% drop in new home sales in May

The trend in retail sales growth is still all but flat and so long as that continues, the RBA will be content to watch as it monitors the growing impact of high oil prices and their influence on inflation.

As it said yesterday: “Inflation is likely to remain relatively high in the short term, and the consumer price index will be further boosted in coming quarters by the recent rises in global oil prices”.

Not other cost increases, such as rising food, steel or car prices: just oil and its products. And so long as oil prices continue to rise, the RBA sees inflation remaining a problem and interest rates won’t be eased.

The bank in fact singled out “fuel costs” for the first time as acting as a restraint on activity:

“The evidence is that the tightening in financial conditions, in conjunction with other factors including rising fuel costs, is working to restrain demand (my emphasis). Indicators of household spending have recorded subdued outcomes over recent months, and credit expansion to both households and businesses has weakened significantly.”

It sees rising oil prices as an inflationary danger, but also wants to use their dampening effect on demand to slow the economy.

This Information is provided to you by the Australasian Investment Review (AIR).
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