US economy to drive rates

THE timing and strength of the US economic recovery is shaping up as the key driver of Australian interest rates over the coming 12 months.

The linkage between the two is based on the US economy’s role as the main influence on global economic conditions.

That, in turn, will dictate whether Australia can sustain its world-leading economic growth for another year.

Macquarie Bank’s David Bassanese speaks for a majority of economists when he says that the global recovery will be slow and gradual.

Consequently, he anticipates a slow pick-up in Australian exports. This will be insufficient to offset the widely anticipated slowdown in the housing sector.

He expects the Reserve Bank will respond by cutting the cash rate by another 0.25 per cent to 4.0 per cent, possibly as soon as next month. Rates will then be on hold for the rest of the year before starting to increase during 2003.

Westpac’s Bill Evans takes a more gloomy view of the economy.

“I think people will be disappointed by the recovery in the US,” Mr Evans said.

He anticipates a downturn in Australian exports, compounding the reversal of the housing boom, leading to higher unemployment. These trends will adversely affect business and consumer confidence.

He expects the Reserve Bank will cut cash rates by 0.5 per cent over the next six months, and sees no prospect of an increase until mid 2003.

This is good news for borrowers with variable rate loans but bad news for investors in cash management accounts and other interest-bearing deposits.

A much more positive view of the global economy is put forward by HSBC chief economist John Edwards.

“The Australian economy is doing well, and likely to stay growing at around 4 per cent per annum, and the US is already starting to recover,’ Mr Edwards said.

A pick-up in exports and business investment in the second half of 2002 is likely to sustain economic growth in Australia. Importantly, the investment recovery is led by major resource projects in WA.

Mr Edwards believes the Reserve Bank will increase the cash rate by at least 1.0 per cent, and possibly as much as 1.5 per cent, over the coming 12 months.

While investors and borrowers should monitor short-term interest rates, which are closely aligned to the Reserve Bank’s cash rate, they also need to keep an eye on long-term rates.

Long-term rates tend to be more volatile, in response to changing market views about the economic and inflation outlook.

These rates determine the yield on investments like term deposits and finance company debentures, as well as the interest rate on fixed-term housing loans.

For instance, the interest rates on three-year fixed-term housing loans and standard variable rate housing loans are currently similar, at 6.1-6.2 per cent per annum.

If the consensus view prevails, the variable rate is likely to dip by 0.25 per cent before stabilising for the rest of 2002.

Over the same period, fixed-term lending rates may fluctuate widely, so borrowers wanting to lock-in their interest payments – before cash rates start to rise in 2003 – need to monitor their opportunities carefully.

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