Wednesday, April 21, 2010

To normal and beyond - the RBA's interest rate path

Hold on

The Reserve Bank isn't done with us yet. The minutes of the April board meeting at which it pushed up its cash rate for the fifth successive time show its members believed the rate would "probably need to rise further," and quickly.

Since October the Bank has pushed up its cash rate from 3 to 4.25 per cent, lifting the typical standard variable mortgage rate from 5.8 per cent to more than 7 per cent and adding $240 to the monthly cost of servicing a $300,000 mortgage.

The minutes make clear that the Bank has been taken by surprise by sudden surges in coal, iron ore and gas prices, saying Australia's terms of trade are now likely to increase far faster than forecast in February driving "strong growth in nominal incomes". While this would benefit Australia it would "also pose challenges."

The wording suggests the bank is in the process of sharply revising up its forecasts for economic growth and its assessment of how high rates need to climb... They suggest that the Treasury is also revising up Budget forecasts.

Unusually the April minutes explicitly cite the "noticeably stronger than expected" jump in the terms of trade as a key reason the Board decided "it would not be prudent to delay" a hike.

They also express concern about a housing market where prices continue to climb despite near-continuous rate rises.

Singling out for blame state governments, local governments and banks they say on one hand "population growth was strong, households had confidence about future income growth, and mortgage rates were at below-average levels," but on the other "the supply of new housing was not expanding sufficiently, partly because of the land usage policies of local and state governments and also because of the tightness of finance for developers".

Although the Bank describes its April hike as "a further step in the process of returning interest rates to more normal levels," they raise the prospect that the Bank will soon feel impelled to push them beyond normal.

"The Bank looks likely to upgrade its outlook for the economy in May," said NAB economist Rob Henderson. "That means rates will need to be above normal."

Commonwealth Bank economist John Peters said he wouldn't be surprised if the cash rate climbed from its present 4.25 per cent to 6 per cent by the end of next year.

"Rocketing iron ore and coal prices have given the Reserve an upbeat view of growth prospects. We still see the cash rate at 5 per cent by the end of the year, but beyond that the Bank will move to a contractionary stance."

A cash rate of 6 per cent would lift the standard variable mortgage rate to around 8.8 per cent, somewhat higher than the 8.57 per cent charged when the Coalition left office but below the peak of 9.36 per cent reached in late 2008.

It would add a further $340 to the monthly cost of repaying a $300,000 mortgage, bringing the total extra monthly impost since October to $580.

Published in today's SMH and Age

Related Posts

. The RBA thinks we're in for a wild ride. It wants rates up first

. Back to Black: "Mr Speaker, tonight I announce a projected surplus..."

. Could our mining boom last another 10 years, another 20?