What Odds A February Rate Rise? The Experts Have Their Say . . .

The Age

Thursday January 24, 2008

Nabila Ahmed

Soaring rent and fuel prices have sent inflation raging in the December quarter into what Reserve Bank governor Glenn Stevens might describe as "uncomfortable" territory, above the central bank's target band of 2-3%. But the decision for the Reserve board, when it meets in 12 days' time, is far from clear cut, with global markets in the grip of unrest and expectations that Australia's voracious spending spree may be coming to an end amid rising fuel prices and tighter borrowing rates. As the central bank prepares for one of its toughest decisions, Nabila Ahmed asks six market watchers what they would do.

THE CASE FOR

HANS KUNNEN HEAD OF INVESTMENT MARKETS RESEARCH, COLONIAL FIRST STATE

THOSE inflation numbers were not good, they will have caused great concern. Inflation will be their No.1 concern, but they also have to have an eye on financial market stability and the state of the economy.

I think if I were Glenn, I would say ,'Look, the financial market will sort itself out, but this economy is growing strongly and there are inflation pressures'.

I would probably bite the bullet and push rates up by 0.25 percentage points.

You'd do it with a heavy heart because you know you're putting the brakes on the Australian economy and it could add some turmoil to an already volatile sharemarket.

But that market must have a life of its own and the Reserve Bank is there to protect us from excessive inflation.

We run the risk of allowing inflation to get away from us if we don't put the brakes on now.

It's finely balanced. You admire the man for taking the job and for doing it as well as he does. This is a tough call . . . raising rates before an election was tough, too, and he has shown he has the moral fibre to do the right thing.

RICHARD GRACE CHIEF CURRENCY STRATEGIST, COMMONWEALTH BANK

INFLATION is certainly suggesting that rates should go up but the global outlook is a little uncertain and that may cause them to delay.

I think the domestic case for a rate rise is pretty clear.

I actually think it would not be good for the dollar if rates went up. One reason is the market may make the interpretation that this is the last rate rise in the cycle and therefore start pricing in chances of a cut for the next move - even if they do that further down the track - so the currency comes under downward pressure as a result of that. Second, there's a small risk the market could say it's a policy error to raise rates in this environment and the currency comes under pressure. I don't think it's a policy error but it will create downward pressure on the currency.

If I were the RBA, I've got to control domestic inflation and I would have to put up interest rates because the economies with which Australia is doing most of its trade are not showing signs of a slowdown at the moment. So I would probably be raising interest rates - and I think the RBA is going to raise rates.

JARROD KERR ECONOMIST, JPMORGAN

INFLATION is strong. We saw that in yesterday's report and the measures that the RBA take most important note of - the trimmed mean and the weighted median came in above expectations and above the RBA's target band.

The domestic economy is growing very strongly and above potential growth. But then you've also got some turbulence in the financial markets and also growing concerns in the US of a recession.

So it's not a clear-cut case in February and the chance of a rate rise has come off in the past few days, especially with the US Federal Reserve coming out last night and easing 75 basis points in an emergency meeting.

There are obviously some concerns internationally and that's why I think it's going to be a close call in February.

We think they are going to go (and lift rates). We think the probability is about 55-60%.

Personally, I would go (and lift rates) in February because I think inflation is what they need to focus on.

THE CASE AGAINST

SCOTT HASLEM CHIEF ECONOMIST, UBS

YES, near-term inflation is high. But the volatility and the uncertainty that's evolved on the global outlook over the past couple of weeks of economic data as well as market moves and the likelihood that the US is going to go into a mild recession - all those factors argue against dealing with that near-term inflation in February. Why not wait a month or two just to see how the economic outlook unfolds?

Our view is that even if the RBA believes the case is already made for a further rate rise, it's difficult to see the urgency to fire it off in February amid the current market volatility and uncertainty about whether the mild US recession could be deeper or emerging market growth proves less resilient.

Inflation is a lagging indicator; the growth outlook is slower. We had a rate rise in August, November, a market-driven one in January (when banks increased their rates in response to the subprime crisis), so if you're going to add another one in February, that's 100 basis points late in the cycle - that's reasonably aggressive I would think.

TIM TOOHEY CHIEF ECONOMIST, GOLDMAN SACHS JBWERE

THE composition of the CPI clearly highlights that it is the demand-crimping elements of inflation (food, rents, utility charges, financial service charges) that are driving the inflation process. These largely reflect supply constraints rather than excessive demand growth. From a broader financial conditions perspective, conditions are already tighter than at any time since the mid-1990s and both business and consumer confidence have fallen sharply.

From our perspective, the RBA's decision is always undertaken on a forward-looking basis. At this stage, we are not changing our forecast of 3.5% for the headline CPI in 2008 and believe that economic growth is already set to slow to a sub-potential pace of 3%.

The RBA should allow the tightening in financial conditions that has already occurred time to slow the economy, rather than rushing into a further rate rise that would result in a more severe slowdown for the Australian economy. The February decision is now a close call but, on balance, we believe the more appropriate strategy is to wait until the global and domestic economic outlooks become clearer.

ALAN OSTER CHIEF ECONOMIST, NAB

IF THINGS settle down over the next two weeks, then it could be February, but we think it will be more likely in March. It all depends on what happens in the next two weeks. For example, if the US Fed cuts another 50 points next week -we think it will be 25, but it could be 50 - and then the markets all rally and everything settles down, then based on pure economics in the local economy, you'd go in February. But if the Fed does 25, the markets get disappointed and you get a few ups and downs again, then the Reserve might just wait an extra month.

I think it's more likely that they will wait. We've got a 45-55% view that they will raise rates in February, compared with 65-35% for March. The market turmoil would be the only thing that's stopping them, so if that settles down by the time the Reserve meets, then they will raise rates. My only problem is I can't see the markets settling within a couple of weeks. They may want to wait an extra couple of weeks to see how the global markets go. Don't ignore the CPI, but give yourself a little bit of time - there is value in waiting and value in time.