Australia | Aug 03 2006
By Chris Shaw
Yesterday’s decision by the Reserve Bank of Australia (RBA) to lift official interest rates by 0.25% to 6.0% was no surprise to the market, but the share market’s negative reaction was based on renewed concerns of a further increase in rates by the end of the year, an outcome that previously had been discounted.
Reflecting this, pricing on the futures market now shows an expectation of a further 0.25% increase in rates by November, which would be the first time in six years the RBA has lifted rates by 0.75% within a six month period.
The Commonwealth Bank has looked at the potential implications for the economy as a whole if the RBA does indeed move to lift rates again by year’s end, which would mean it has matched its actions of 2000.
The first point it makes is there is a lag effect, so it will take time for any implications of the recent series of rate increases to flow though into economic data for the broader economy. That said, the news is not great, as the likely impact is a downturn in most of the important economic data such as consumer and business spending, with the impact to become more obvious in 2008.
One area expected to be among the hardest hit is construction, as the higher borrowing costs stemming from higher interest rates reduces the incentive to take on additional debt. As a result, both housing and business construction is likely to turn down, the broker estimating there would be a 1.5% fall in construction activity.
Consumer spending would also suffer, as higher mortgage payments means less cash in the pocket for discretionary spending. On the bank’s numbers, expect a 0.25% fall in consumer spending numbers if rates go up again.
Higher interest rates also boost a country’s currency, which in Australia’s case is bad news as it will reduce the competitiveness of our exports, which has long been a significant driver of our overall economic growth. This would flow though to a fall in the GDP number overall, though the bank suggests the impact would be modest at about 0.25%.
Translating all this to equities, the bank expects a further move up in rates could have a modest impact, its estimate being for a 0.2% decline in output for the market overall. Obviously some sectors would be more affected than others, the bank suggesting those most likely to suffer include industrials, with output down an estimated 0.4% and the materials, consumer staples and consumer discretionary sectors, where it forecasts a 0.3% decline in output.
Will rates go up again this year? While suggesting the market is being too quick in factoring in another rate increase before the end of the year, the bank suggests the best insight into this question will come tomorrow when the RBA releases its latest "Statement on Monetary Policy".