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Rates rise on the cards

THE Reserve Bank was expected to lift official interest rates after its board meeting this week.

Whether it moved this week, or next month, it is inevitable that rates will increase over the rest of the year.

The critical question, then, is how high rates will go during the current tightening cycle.

The overnight cash rate set by the Reserve Bank is currently 4.25 per cent.

The overnight rate (plus a profit margin) determines the interest rates on most lending and deposit pro-ducts, such as housing loans, business overdrafts and cash management accounts.

Reserve Bank Governor Ian Macfarlane last month provided a guide to the future.

“It is reasonable to expect that interest rates will rise from the current low level to more normal levels over the course of the next 12 months,” he said.

HSBC chief economist John Edwards said a “more nor-mal” level for the overnight rate would be its average for the past decade, which is a touch higher than 5.5 per cent.

He expects the official rate will reach 5.25 per cent by the end of 2002 and peak at 6.0 per cent in mid 2003.

The increase is aimed at slowing consumption growth, in order to avoid a collision between an incipient investment boom, renewed export growth and strong household demand sustained by rising employment, rising house prices and rising incomes, Mr Edwards said.

Westpac chief economist Bill Evans describes the interest rate cycle as moving around the “neutral” mid-point, of about 5.25 per cent

At current levels, interest rates are clearly expansionary.

He expects the official rate will peak at 5.75 per cent in 2003, at which point monetary policy will be “leaning against growth a little”.

Commonwealth Bank senior economist David Moore concurs with the general view that rates will remain low by historical standards.

He said the Reserve Bank would be very wary about lifting rates too far or too fast.

This reflects the risk that economic growth will be weaker than generally fore-cast, especially with the housing boom expected to taper off.

“There is also a question mark over the durability of the US economic recovery, with consumers already stretched and business investment weak,” Mr Moore said.

Westpac’s Mr Evans said weakness in the US would have flow-on effects in Asia and adversely affect Australian export growth.

A further risk is a fast jump in the Australian dollar, which also would adversely affect local exporters.

On the other side of the equation, there is a risk that inflation will stay above the Reserve Bank’s target range of 2-3 per cent, forcing interest rates even higher than currently expected.

On balance, Mr Moore expects inflation will not be a problem.

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