FYI | Aug 23 2006
Why interest rates in Australia are likely to rise further.
Oil prices are down, but let’s be honest: doesn’t everybody have the feeling that US$78 per barrel is never far away?
Several investment strategists have started to point at the weak outlook for Asian equity markets over the past few weeks. Most noteworthy in all these strategy pieces, I found, was the apparent fact that Asian companies find it hard to pass on rising costs. (Thus their profitability is in decline which reduces their share price potential).
This is good news for consumers in developed countries, like Australia. At times when your own economic infrastructure is still running close to full capacity, what you don’t want is Asian exporters raising prices. Not at times when inflationary dangers are still very much in the balance.
A few weeks ago I wrote what the world needs right now is some bad news, although not too bad, of course. The latest US economic data were bad (thus good) and China has further tightened domestic liquidity, though it still remains an unanswered question whether anything put in place thus far will stop the Chinese economy from running ahead of itself too far.
Many open questions aside, we’ve had some encouraging developments recently, including oil retreating, and equity markets have not hesitated to use the moment and move higher.
Nouriel Roubini, however, sees it differently. A few weeks ago I mentioned how Roubini, professor economics in the US with a blog reputation, had come to the conclusion it was already too late to save the US economy from landing into another recession next year. Roubini has used the recent economic data in the US to reiterate that view.
All this shows that expert opinions and views are still very much divided, and they are likely to remain so for at least a few more months. Investors better not expect the recent volatility to subside anytime soon.
One of the golden rules Morgan Stanley chief economist and global strategist Stephen Roach has reminded his readers of repeatedly over the past two years is to never bet against the US consumer. History shows it almost never pays off. Stranger things have happened of course.
Amidst all these international questions and developments, I feel the internal factors contributing to Australia’s inflation danger have not received the amount of attention they deserve. We all know about the infrastructure at near full capacity, including a workforce in heavy demand (unemployment at record lows and skilled people in acute shortage), because of the Reserve Bank highlighting these points to justify its two hikes so far this year and its ongoing tightening bias.
But what about the housing market?
The housing market in the US is cooling and Australia is repeatedly (up to a point of annoyance) cited as the leading example of how and why it all should end with a soft landing.
What is never mentioned (not seldom, but absolutely never) is that housing in Australia should be bouncing back soon.
Investors better take note because the implications are wide and varied.
Sticking to the interest rate angle of this story: if things pick up a little bit too swiftly we could be talking an extra push to the domestic inflation figure before we have an answer to the question whether oil prices are likely to meaningfully retreat from here or not.
And that’s why the Reserve Bank of Australia will feel comfortable in pushing up interest rates to 6.25% and, who knows, possibly even to 6.50% over the next few months. Says TD Securities’ outspoken inflation hawk Stephen Koukoulas.
Koukoulas released his latest survey into Australian housing today, reminding everyone the underlying factors in Australia are still very much bullish. There are simply not enough houses and apartments built for the growing population in Australian cities and this will lead to a swift recovery, he predicts.
Because of the lag when newly built premises come on the market, price pressure will come first. Already, he says, the housing shortage has spilled over to a tightening in the rental market. The latest CPI data showed dwelling rent rose 3.0% in the year to Q2. This was the fastest annual increase in five years. (And nobody else noticed?)
Koukoulas says anecdotal evidence suggests new rental agreements are seeing rent increases of 10%.
A rental market that is tightening and house prices that are moving higher again: we all know where that leads to; borrowing levels on the increase. Koukoulas reminds us all borrowing levels jumped by 25% between August 2005 and June 2006.
The RBA hiked twice already this year. Koukoulas believes the eyes of the central bankers were firmly focused on the domestic housing market while doing so. But with such a strong positive demand led support, he simply thinks it won’t have the desired effect.
Higher interest rates have multiple impacts. For investors it means the Aussie dollar is likely to remain stronger for longer. Aussie bonds are probably not the best place to park your money right now.
For the share market in general, however, this would mean the clouds of potential further RBA hikes are not going away anytime soon either.
Till next week!
Your happy as long as I don’t have to leave my current rental flat editor,
Rudi Filapek-Vandyck
(happily supported by the Fabulous Four: Terry, Greg, Chris and Rob)