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Interest rates to rise in 2011 – but why?

Speculation as to when we can expect the Reserve Bank to make another move on interest rates has been rampant since the beginning of this new decade. Adding to the debate among economic analysts has been the potential impact of the string of natural disasters that occurred recently and Australia’s overall fiscal health.

So what does the central bank have in store for 2011? And exactly what fundamentals will they be keeping a close eye on to direct their monetary policy?

Since the Cup Day rate rise last year, the RBA has sat tight on the official cash rate of 4.75% and giving testimony to the Parliamentary Economics Committee, Reserve Bank Governor Glenn Stevens indicated that they would continue to do so in the immediate future.

Mr Stevens said that he is, “fairly content with where we are at the moment.”
“We are in a good position. We are ahead of the game, which is where you want to be and that’s the thing that affords you periods of sitting, waiting and watching and sometimes they can be reasonably lengthy periods of time.”

Just how long the RBA intends to wait and watch depends on a number of factors that will influence the general performance of Australia’s economy into 2011 and the rate at which inflation tracks throughout the year.

So let’s take a look at some of the things Mr Stevens and co will be keeping a close eye on…

Jobs growth
Employment in Australia is on the rise, with most people who are willing and able to work now being afforded the opportunity to get a job. Economists consider 5% unemployment – the figure recorded by the Australian Bureau of Statistics for January – to be full employment, and it is this tight labour market that’s expected to push up wages, spending and inflation.

The forecast jobs growth of 17,500 nationally for the month of January was nowhere near the actual figure of 24,000 and with fewer workers on the open labour market; economists predict that higher wages will be negotiated as employees begin to hold the upper hand.

As we know, higher wages means greater consumer confidence, which could encourage Australians to loosen the reins on their proverbial purse strings and start spending more on goods and services.

Of course if the RBA sees this turnaround as happening too rapidly, they will raise interest rates to bring us back down to earth and try to stop us from splashing too much cash.

HSBC chief economist Paul Bloxham and ANZ senior economist Amber Rabinov both agree that the strong labour figures will encourage the Reserve Bank to lift interest rates in the middle of the year.

“As employment heads below 5 per cent, which we expect will happen soon, the Reserve Bank will become increasingly concerned about inflation,” Mr Bloxham said.

“We still expect the next rate rise in May or June.”

The forces of Mother Nature
While some are suggesting that the recent flood crisis in Queensland, as well as the devastating impact of Tropical Cyclone Yasi, will have little affect on interest rate movements, others believe the mammoth clean up that lies ahead could have significant consequences for the overall economy.

Concerns as to the impact of these natural disasters relate once again to employment levels, with many experts predicting a surge of new jobs in industries such as construction as more skilled trades are required to help with recovery efforts.

However the RBA itself has confirmed that the floods, as an isolated incident, will not sway their evaluation of where interest rates should be set saying, “The focus of monetary policy will remain on medium-term prospects for economic activity and inflation.”

The RBA adds, “In setting monetary policy the Bank will, as on past occasions where natural disasters have occurred, look through the estimated effects of these short-term events on activity and prices.”
“The Bank’s preliminary assessment is that the net additional demand from rebuilding is unlikely to have a major impact on the medium-term outlook for inflation.”

Costs at the checkout
One thing the experts agree on is the inevitable price rise we can all expect to pay at the checkout as a result of the recent battering Queensland’s agricultural sector has taken. It is anticipated that fruit and vegetable prices will start to soar as losses of Queensland crops impact supply.

However this price rise should be absorbed, in the short term at least, by decreasing retail prices and the falling cost of imported goods due to the continuing strength of the Aussie dollar. Additionally, the poor performance of the manufacturing and service sectors is currently keeping a lid on inflation and giving the Reserve Bank some breathing space.

Mining boom
China’s obsession with our abundant natural resources has probably been the biggest concern for the RBA over the past year and will continue to be well into the future. The Central Bank anticipates that the Chinese demand for Australia’s mining exports will last for at least another 25 years.

Of course this resources boom is not only increasing the flow of overseas funds into Australian coffers, it is also creating further jobs and an increase in capital expenditure as more infrastructure is required to keep up with China’s insatiable demand.

If consumer sentiment, the local property markets and business confidence were all as robust as the injection of overseas income into our economy, you can bet your bottom dollar that interest rates would already be on a steep upward trajectory.

But at present, the two sides of the equation – sluggish local spending on the one hand and vigorous overseas interest in our natural resources pouring money into the economy on the other – are balancing each other out and maintaining inflation at a reasonable level.

Property prices
There is no doubt that a booming housing market generally means high inflation and rising interest rates. When we are freely spending money locally on real estate, all of the furniture and goods required to make a home and the building of new accommodation, the economy is usually at its peak and confidence abounds among consumers.

At present, and in fact for the last ten months or so, property prices have been fairly stagnant across the board in most of our major capital cities and it is expected that price growth will continue to flatline and possibly fall slightly for the remainder of 2011. This is another area that the central bank has been forced to consider when determining their move on rates.

Many analysts believe that one of the main reasons for the slow down in new home lending and the housing markets in general, is the barrage of rate rises we were hit with over 2009 and 2010 and the RBA have taken this on board.

In their February meeting the Reserve Bank noted, “In the household sector thus far, in contrast, there continues to be caution in spending and borrowing, and an increase in the saving rate. Asset values have generally been little changed over recent months and overall credit growth remains quite subdued, notwithstanding evidence of some greater willingness to lend.”

The bottom line is, all of these factors are not singularly going to create an inflationary environment that sees the RBA take action on interest rates. Rather, they are all working together to create the economy of the day.

As the job market continues to tighten, the perception of wealth grows due to overseas spending on our shores and things start to again pick up locally in terms of consumer confidence and spending, there is no doubt that the delicate balance we are currently seeing will once more tip inflation into concerning territory for the RBA.

With this in mind, we believe investors and home buyers should avoid becoming complacent in the first half of the year as interest rates remain steady. You need to be mindful that the economy will start to move at greater speed and by mid-year, we will begin to see a tightening of monetary policy to ensure inflation remains in check into 2012.

Essentially, I agree with those analysts who are predicting a 1% rise in the official cash rate by this time next year and suggest that all property owners factor such a move into their budgets for the next twelve months.



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Rolf is Director of Metropole Finance and has twice been voted Australia's leading finance broker. He shares his wealth of knowledge about how to best use property finance to fund investments.
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