Markets Tip More Interest Rate Pain

The Age
20 February 2008
Tim Colebatch, Economics Editor

FINANCIAL markets have marked down another interest rate rise next month as a virtual certainty, after the Reserve Bank revealed it came close this month to delivering two rate rises at once.

The minutes of the Reserve's board meeting two weeks ago show it seriously debated lifting rates by half a percentage point in one hit - adding $100 a month to the cost of servicing the average new mortgage - to send Australians a signal about the seriousness of rising inflation.

In the end, the board decided on the usual rate rise of 25 basis points. But the minutes add: "However, the judgement was finely balanced, and the board would continue to review whether policy was sufficiently restrictive to return inflation to the 2% to 3% target within a reasonable period."

Among the reasons it held back was that "additional tightening could be implemented at the March and/or subsequent meetings as judged necessary".

The Reserve has lifted its cash rate from 5.25% at the start of 2005 to 7% now. Another rise would add $50 a month to the cost of servicing a $250,000 mortgage, on top of rises of almost $400 a month from earlier rate hikes and higher bank margins.

Yesterday, Reserve assistant governor Malcolm Edey warned that the official inflation figure was likely to rise to 4% in the current quarter, as last year's falling banana prices drop out of the index.

He predicted that even without further rate rises the economy would slow rapidly this year, with economic growth excluding the farm and mining sectors braking to 2.5% by December and 2.25% by mid-2009.

Further rate rises would imply an even sharper slowdown, with rising unemployment and business failures.

Markets yesterday took the Reserve at its word. They lifted the odds of another rate rise on Tuesday week to 90% - with one bank warning there could be a series of interest rate rises ahead, pushing the standard mortgage rate close to 10%.

ABN Amro bank economists Felicity Emmett and Kieran Davies argued the Reserve could deliver another three interest rate rises, unless a financial market meltdown gets in the way.

Using the Taylor rule, a widely quoted formula for determining interest rates, they said: "The cash rate could get to 7.75% in order to bring inflation under control."

Ms Emmett and Mr Davies forecast that the commercial banks were likely to hike their interest margins again, following big write-offs of bad loans by the ANZ and other banks.

This implies that in a worst case scenario, the standard variable mortgage rate could rise to almost 10%."The (Reserve) Bank has further to go," they said.

"More importantly, if wages finally pick up this year, the RBA could become more aggressive, as it would want to stop the recent pick-up in inflation from being entrenched."

Analysts agreed that the minutes, released under the Reserve's new openness policy, underlined that the bank now saw itself at war with inflation, and it was prepared to impose a lot of pain to get it back under control.

Dr Edey yesterday cited national accounts figures as evidence that wage growth has accelerated to a trend level of more than 5%. But more authoritative figures today will test that view, when the Bureau of Statistics releases its wage price index.

There was conflicting evidence yesterday. The Melbourne Institute released a survey reporting that hourly wages rose just 2.9% in the year to February, in line with their average since 2000.

But a small business survey for the Australian Chamber of Commerce and Industry reported wage growth at the highest levels in 12 years of the survey.

Australia's interest rates are already the highest in any developed country other than Iceland and New Zealand.

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