Australia | Nov 07 2007
By Chris Shaw
The Reserve Bank of Australia (RBA) surprised no one today with the decision to lift official interest rates by 0.25%, so economists have focused on the bank’s accompanying statement to gauge the outlook for rates going forward.
As Westpac chief economist Bill Evans notes the statement was hawkish as it made it clear the RBA still regards inflation as a threat, particularly as there are few signs of any diminishing in the strength of domestic demand and the threat of a wages blow-out remains. As a result Evans points out underlying measures of inflation are likely to be above the RBA’s target of 3% by the March quarter next year, which suggests further rate hikes in coming months.
TD Securities senior strategist Joshua Williamson attributes the inflation issue to the terms of trade boost Australia has enjoyed from the combination of stronger demand for its products (commodities in particular) and falling prices for the primarily manufactured goods it buys.
In simple terms Williamson explains it as Australia is getting buckets of money for the things it sells and paying next to nothing for what it buys, which would usually translate into an improvement in the budget surplus.
This hasn’t happened though as the government has given away the surplus through the tax cuts it has implemented in recent years, which in itself is not bad policy but has the effect of adding to demand as consumers enjoy a positive wealth impact from their reduced tax burden.
As the automatic stabiliser of an increased budget surplus is not there the terms of trade needs a stronger Australian dollar as an offsetting force, but here the currency has lagged as on Williamson’s numbers the Australian dollar should be at around US$1.20 to fully offset the terms of trade boost.
This not happening means rates are likely going to go higher, Williamson suggesting if 7.0% interest rates are not enough to stabilise the economy it may require increases to as high as 7.5%.
Needless to say the TD Securities view is of further rate hikes, with moves expected in both the first and second quarters of next year. Evans isn’t waiting that long, picking a further hike in December and a further move sometime in the first half of 2008.