stevensfamily

Double rate rise: RBA's shock plan

February 20, 2008


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 Reserve board decided on the usual rate rise of 25 basis points, or a quarter of a percentage point.

But the minutes added: "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 rate was likely to rise to 4% in the current quarter. He predicted that even without further interest rate rises, the economy would slow rapidly, with growth excluding the farm and mining sectors falling to 2.5% by December this year and to 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, lifting the odds of another rate rise on Tuesday week to 90%. One bank warning there could be a series of 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 got in the way. They also predicted that banks would lift their interest margins again - putting rates up independently of any action by the Reserve - following big write-offs of bad loans by ANZ and others.

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.

Conflicting evidence on wage growth emerged 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.

DrWho

Hmm... with the RBA and BOE heading in opposite directions you might see 2 to 1 rather more quickly than you thought...

bcworld

Well March's rise is 95% certain and is now priced in at $2.12. What would really cause the A$ to appreciate further is if they decided to go +0.5% in March...even if they don't do that, they will probably go again in May.

The risks for A$ are all on the upside...so as per the other 2 exchange rate threads you have going (why not keep em all in one??)...there's no fundamental reason to expect the exchange rate to improve in your favour.

stevensfamily

Guys I dont understand why the $ is strong when the economy starts to suffer. In UK we have repossesions up and inflation rising so why does the £ weaken and yet with simular situation in Oz the $ gets stronger?

Please help I dont understand

Grayling

It is basically down to interest rates.

They are dropping in the UK and rising in Australia.

NikiL

As Gray says its down to interest rates. The Aus$ has a high interest rate, so overseas investors want to buy the Aus$ to invest as they will get a higher rate of return. Because there are more people wanting to buy the Aus$ it is more attractive, so you get less bucks for your pound (or whatever currency you're exchanging).

MartinLuther

It's because the economy here has not started suffering yet. A prediction that it will start to suffer is just a prediction. People are still spending and driving inflation.

stevensfamily

Do investors not worry about stability then? why did we not benefit when the exchange rate stayed level by BOE they did not put rate down as expected the last time but we saw no increase in the exchange rate in fact it still dropped. I thought that we suffered due to instability in the economy (Northan bloody Rock!!! etc and house reposessions) seemed to be a major factor in the instability of the £.

The US dropped rates to stabalise the $, so they would have been better to put them up!!!

Confused, give up
Although the exchange rate has just gon up to $2.13 up from $2.10 OMG cannot belive thats exciting

bcworld

The thing is the situation is not similar. In Oz there is rapid economic growth (4%+), unemployment at generational lows, still rapidly increasing consumer spending (something like +8% year on year), housing market which in many locations is very much on the rise again.

Its not perfect....the growth isn't well balanced between the states, but as a big picture the country is booming....probably too much so and consequently inflation is very much on the rise. I actually think, the way things are going that there is a real danger of bust following boom here but I wouldn't expect it to come off the rails in the next 12 months or so.

stevensfamily

Thank you , will just sit it out in my rented home as my house wont sell because UK is stagnant, and exchange rate pants.

I will stop this now as I realise my panic is annoying those who have already moved and its only those sitting on the edge of the cliff who really understand the major wobbles that come at this time. Those who have already jumped and are living the life probably cannot think back to those last few weeks when everything is questioned everything is magnified and the fear prevents normal thinking and rational behaviour.

I will stop bugging everyone sorry but this forum is my agony aunt and without you all I probably would not get through all this.

Again thanks for being tolerant of the mad woman.

Cheryl

NikiL

The UK has been hit by the subprime market harder than Aus (so far), and Australia had still been raising their rates, even though the UK's hadn't dropped, which still makes it more attractive to investors. The long term forecast is a factor in exchange rates (ie what the markets expect to happen with interest rates) and at the moment the one year spot forward is $2.18, so they're not expecting much improvement for a while. That can always change (and frequently does) but it gives you an idea.

And no, stability isn't that much of a factor for major currency investors - have you ever heard of George Soros? He's decribed as the man who broke the Bank of England in 1992 from currency speculation.

NikiL

Nothing wrong with wanting to understand why a major factor affecting your life going forwards is doing what it is doing

Amazulu

I wonder how long the RBA can continue putting up rates whilst the rest of the world is reducing theirs? Somewhere along the line the gap is going to get so big it's going to be an issue and the Aussie gov. is going to have to look at other ways of keeping inflation in check.

Vim Fuego

And if you understand enough then you can actually make some money out of it ... me, I've got more chance at the TAB.

stevensfamily

Thank you so much for calmly and clearly explaining things to me, I have taken this info onboard and now understand that I have to watch intrest rate rises in Oz and rates in UK to understand which way the market may reflect the situation. Whilst inflation is rising in Oz even though they are seeing reposessions inflation is so important to control that they will raise intrest to encourage saving not spending and to control spending due to increased living costs. Once they slow the intrest rates can come down but will take time I suppose otherwise spending will kick off again!.

Uk is a few steps ahead and so we have slowed so rates may rise to incourage savings (Northan Rock needs searious savers to get it out of debt soon as possible, lets hope the government encourage rate rises to get out of that hole)

Anyway,

Thanks so much and Karma to you for explaining things to me.

Cheryl