Australia | Nov 02 2007
By Chris Shaw
The Melbourne Cup is next week but economists are engaged in a slightly different betting market, attempting to predict just how far Australian interest rates may go in coming months.
According to Westpac chief economist Bill Evans the market should be putting its money on a trifecta of interest rates hikes in coming months, starting with next week’s Reserve Bank of Australia (RBA) meeting.
Having previous highlighted the possibility of a follow-up rate hike in December Evans now expects such an increase, suggesting recent data for both the domestic and global economy have only strengthened the case for the RBA to move again before the end of the year.
As evidence Evans notes global credit markets are now returning to close to normal following the volatility of recent months and the global economic growth outlook remains solid, while in Australia specifically the tax cuts promised by both parties in the lead up to the election are likely to provide further stimulus to an already strong economy.
In addition Evans suggests the RBA remains of the view households have yet to reach their limits with respect to debt levels, meaning interest rates are not yet impacting on economic activity, while CPI data were strong last month and are expected to remain elevated in coming months.
With September development approval data indicating the housing market may finally be turning the corner and equally strong retail trade numbers for the period it is clear the Australian economy remains strong and this supports further action by the RBA in his view.
While the ANZ Bank economics team is also forecasting three more rate hikes and a peak interest rate of 7.25% by the first half of next year Commonwealth Bank chief economist Michael Blythe is not so sure, though he too agrees rates will increase by 0.25% next week.
He has targeted February as the time of the next RBA move of a further 0.25% increase to 7.0%, which is his pick for the top of the rate cycle. He too expects the next CPI data to support the case for a further hike, but points out rates of 7.0% would be restrictive when viewed on traditional measures and so may help slow the economy somewhat.
He also suggests there are some downside inflation risks that could come to the fore in coming months as the bank is positive on the potential for a supply side expansion in the Australian economy on the back of increases in both labour supply and capital stock.
This would lift the economy’s potential growth rate and so reduce some of the inflationary pressures currently being driven by the existing capacity constraints, but Blythe admits he and the bank have a relatively optimistic view of the inflationary outlook.
A good indicator for future interest rate hikes in his view is the employment rate, as in recent times there has been a strong correlation between short-term movements in unemployment and the level of the cash rate.
Assuming the Westpac view comes to pass and there is a further rate hike in December, Evans sees the Australian dollar as a major beneficiary as the market is currently not pricing in such a move.
From around US93c before yesterday he sees it hitting 96c by early next year and remaining around that level for much of the first half of 2008.