The Reserve Bank is likely to raise interest rates again next year, after increasing the cash rate by 25 basis points to 6.25% yesterday, according to leading economists.
Yesterday’s increase is eight rate hike in the current tightening cycle that began in May 2002 with a cash rate of 4.25%. RBA Governor Glenn Stevens said the decision was taken against a background of continued expansion in the global economy, which has grown strongly in 2006 and is generally expected to grow at an above-average pace in 2007.
“Although growth in the United States has moderated recently, strong conditions are prevailing in other parts of the world. The global expansion has contributed to high levels of commodity prices, which continue to add to incomes and spending in Australia,” he added.
Stevens said that the Board judged this to be an environment in which the risks of inflation exceeding 2-3% over the medium term remained significant.
He added that while the monetary policy has been responding to these risks for some time, with increases in interest rates in May and August, the Board’s judgement was that a somewhat more restrictive stance of monetary policy was required in order to moderate inflation over time.
AMP Capital Investors’ chief economist Shane Oliver said while he hopes that this is the interest rate rise, he fears the statement from Stevens suggests that central body still has more interest rate rise on its agenda.
“Our view of the world economy is more subdued than that of the RBA. Inflation around the world will slow down and recent growth has been driven by falling fuel prices,” he added.
Jones Lang LaSalle’s national head of forecasting services John Sears said the probable rate rise will be on February 07, 2007.
“Currently, the market is pricing in a 28% probability of a rate rise then. However, at this stage, this should just reflect the RBA’s tightening bias as a lot of additional data needs to flow under the bridge and be run up the flag pole before Glenn Steven’s salutes, or even raises rates,” he added.
Economists are saying the RBA should take a breather and not hastily pen in another rate rise.
The sentiment was echoed by Oliver, who said that overtime the RBA will realise that they have done more than enough with the latest interest rate rise. He added that the market is only beginning to feel the impact of the August rate rise.
“Looking at the housing data, it takes approximately three to six months for the market to show the full impact of an interest rate rise.
“And the impact of business investment, which drives the economy, takes up to one year,” Oliver said.
Meanwhile, Stevens said the Board took careful note of the likely economic effects of the drought, which will lower the supply of rural produce, reduce farm incomes and may temporarily affect prices for some foodstuffs.
“At this point, these developments appear unlikely to affect significantly the medium-term outlook for inflation,” he said.
“Domestic demand has been expanding at a relatively strong pace against a background of limited spare capacity. Labour market conditions have remained tight and businesses are reporting high levels of capacity usage. While there have been some tentative signs of moderation in the demand for credit recently, the overall pace of credit growth has remained strong.
“This combination of forces has contributed to an increase in inflation. In the September quarter the underlying inflation rate was around 3%, up from 2.5% at the end of last year, and it is likely to remain around that rate in the near term.” Stevens concluded.
Oliver said an interest rate fall will likely come at the second quarter of 2007 for the following reasons:
“Firstly global growth is slowing down led by the US and secondly business investments, which has fuelled domestic growth is beginning to slow down.
“Thirdly, consumer spending is flagging down and the drought is expected to knock 1% off economic growth,” Oliver concluded.
Additionally, the TD-Melbourne Institute Inflation Gauge for October suggests that inflation pressure has waned with no change in September and October after a 0.6% rise in August.
By Nelson Yap
