Tighter rates on the cards

THERE seems to be a decided sense of agreement by economists about the direction of interest rates in Australia.

When economists agree a great sense of trepidation is felt by commentators and the public.

Since late in 1999, the Reserve Bank of Australia (RBA) has raised official interest rates by a total of 150 basis points to 6.25 per cent.

The bank has also cited a number of reasons for doing so, including stronger than expected economic growth, and the prospect of rising inflation.

The rising inflation has been fuelled in part by an Australian dollar, which despite all of our expectations, continues to languish with little or no sign of recovery on the horizon.

Since the tightening began, growth has continued to be strong and clearly above trend. Inflation forecasts have been pessimistic compared to the reality. And the Australian dollar has fallen around 25 per cent.

The GST introduction on July 1 was supposed to be the end of the world as we knew it and that has come and gone with nary a whimper.

The GST induced price rise has not flown through into the average wages growth figures yet and all of a sudden the world is not such a bad place to be in.

All of this should certainly be giving the RBA a great deal of comfort about the medium term outlook for inflation.

So where to from here for the RBA’s view on monetary policy?

- Treasury forecasts for a stronger growth rate from our economy and the creation of a stronger than expected surplus are far from suggesting that we are in an overheating economy. The fall in unemployment brought about as a result of the strong growth in the economy has not resulted in a marked acceleration in wages.

- The rise in the CPI headline rate was the concern at the time of the introduction of the GST. The September Quarter CPI figures suggested these fears were unfounded. The prospects of wages growth demands as a result of the CPI blowout appear to have receded somewhat.

- Traditionally, the RBA has tended to view the inflation impact of a weaker Australian dollar and higher oil prices as being temporary. Hence the RBA has tended not to use monetary policy to counter these impacts. However, if the weaker Australian dollar and the higher oil prices hang around for considerably longer there is a danger they could feed into inflation expectations and hence into wage and price setting decisions. At that point they will have become more than temporary influences on the inflation outlook. So far there is little evidence that either of the factors is being entered into our expectations. Whilst this remains so we will not need to see the RBA change the monetary policy settings.

The case to change monetary policy is markedly weak at best.

The RBA however, has indicated it will look to take out a touch more insurance against the risk of adverse movements, particularly in the area of a wages spike.

The increases we have seen in the rates have certainly not stopped consumer spending with household debt levels being extraordinarily high. Another rate rise or two is unlikely to change that. With that assurance, the RBA could well tighten policy a little more.

The timing on this may have more to do with the state of the Australian dollar, the US Presidential elections and the view that traders in foreign currency markets take of the relative merits of our currency against others.

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