Two rate rises by the end of year could be a small price to pay…

It is becoming increasingly apparent that economists who have been predicting a rate rise from the Reserve Bank before the end of the year have been consulting a very accurate crystal ball.

According to ANZ’s latest Australian Monetary Policy Update, rather than a barrage of rate rises as we experienced at the beginning of 2010 however, this time around the RBA have a chance to pre-empt inflationary risks and move on the cash rate with less brute force.

The ANZ report suggests that the RBA would be wise to announce two rate rises, of 25 basis points each, by the end of 2010 – a scenario that is looking more and more likely if commentary from the RBA itself is anything to go by.

They say this would constitute a “discreet adjustment to the cash rate, targeting a lift in interest rates in the economy of between 40bp and 70bp.”

ANZ says these anticipatory moves by the RBA to restrict our accelerating economy and inflationary pressures in 2010, will mean borrowers could be protected from a rapid succession of increases during 2011.

The report states, “We also retain our view that the cash rate will need to move to a restrictive setting, to between 5.50% and 6.00%, by end 2011. But the move to a restrictive setting will not occur quickly. By moving pre-emptively in 2010, the RBA will gain some space to assess developments in the local and global economy.”

The ANZ document says it has become increasingly apparent that the RBA has to take measures now to keep inflation in check into the near future, with various economic fundamentals pointing to a booming economy as we enter 2011.

“ANZ has long held the view that strengthening growth momentum, little spare capacity in the economy and inflationary pressures would see the RBA raise its cash rate by year-end.”

It says this prediction has been confirmed by recent commentary from the RBA, who intend to address, “the inflationary consequences of the current terms of trade and impending investment boom.

“Australia’s economic fortunes are tied to that of Asia and the commodity markets. But one of the most tangible risks to economic outlook that policy makers can control over the next few years is a surge in inflation and interest rates in the presence of high levels of household debt.”

The main concern raised in the ANZ report is that history indicates investment booms (the likes of which we are currently seeing in Australia’s resources sector) and household booms, create an inflationary pressure cooker.

Given that unemployment is currently at a very low level (only 5.1%), the potential for increased household spending is very real. And RBA Governor Glenn Stevens has recently been quoted as saying Australia is set to, “experience the largest minerals and energy boom since the late 19th century.”

Bearing these two factors in mind, along with the June quarter inflation rate of 2.7% (in the top half of the RBA’s target inflationary band between 2 to 3%), the ANZ report says, “it is clear where the medium-term risks to inflation lie.”

ANZ says the RBA need to tackle inflation before it spirals out of control, as occurred in 2007-08, “when policy settings were driven too much by the concurrent domestic data flow instead of the medium-term risks.”

“Such a ‘data driven’ monetary policy approach in this commodity boom would conceivably see interest rates on hold for another six months but raise the risk of a more aggressive increase in rates later in 2011. To move interest rates early is to move interest rates less over the course of the cycle.”

This kind of forward thinking monetary management is critical right now, particularly given that the RBA’s own outlook is for underlying inflation to return to a high 3.0% by mid-2012.

In other words, borrowers will conceivably be better off taking a hit to the hip pocket in the form of higher repayments before Christmas; a move that might make the RBA seem like a bit of a Grinch in the short term, but that could save home owners and property investors from an interest rate rampage later in 2011.


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