Australia | Oct 09 2006
By Chris Shaw
Australian financial markets may only be pricing in a 40% chance of a further increase in official interest rates before the end of the year, but in the view of chief strategist Stephen Koukoulas of TD Securities this is an error in judgement as the real risk of an increase, and possibly more than one, should be regarded “significantly higher”.
The low probability is, according to Koukoulas, a reflection of the slowing US economy and the likelihood this will bring downward pressure to bear on inflation in Australia. He suggests the problem with this view is the market has forgotten the Reserve Bank of Australia (RBA) considers more than just the US economy when deciding on interest rates. Asia and its demand for our commodities is providing a boost and Australia’s growth outlook remains solid, so expectations for the US don’t automatically extend to our market.
Koukoulas expects new RBA governor Glenn Stevens to commence bringing the market around to the idea of further increases in rates when he gives a speech to Australian Business Economists on Wednesday, in part because such a move makes sense given his recent promotion to the top job.
As Koukoulas points out, with Stevens having only recently taken over he hardly wants to risk being responsible for allowing inflation to run out of control, particularly as unemployment is low and the housing market is reasonable. As a result, Koukoulas suggests the risk/reward environment favours Stevens and the bank moving rates higher.
This is particularly the case given inflation data itself remains strong, as the upcoming release of data for the September quarter is expected to show an annual inflation rate of around 3.75%, with core inflation of just more than 3%. With strong credit growth and a tight labour market, Koukoulas suggests inflation appears unlikely to simply trend back to within the bank’s target range.
Further, with next year an election year it is almost a certainty in Koukoulas’s view the government will offer additional spending and tax inducements in the next budget and prior to the election, with these to boost the overall economy. Again, such an outcome makes it difficult to see how inflation can simply move back within the RBA’s target range without the help of further rate increases.
The final reason Koukoulas suggests the market should in fact be looking for a rate increase in November rather than December is as margins have contracted in the lending sector, the full impact of previous rate increases has not flowed through to consumers. This means while rates have gone up it hasn’t had the full impact that would previously have been the case, so a further rise or two may be required to make up the shortfall brought about by lower lending margins.
If there is a change in expectations and a rate increase is factored into the market outlook Koukoulas cautions of a likely sell-off in bond and interest rate markets, while the yield curve would be likely to invert even further as bond spreads increase.