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What impact will world events have on local interest rates?

With Australia’s economy now very much an integral part of the global stage, it’s expected that the tragic earthquake and Tsunami that has crippled much of Japan is likely to have some type of impact on local monetary policy when the Reserve Bank meets over the next few months.

Then of course there’s the unrest in Libya concerning Gadaffi’s tyrannical reign, which has seen the outbreak of a full scale civil war with many innocent civilians losing their lives.

While these events are devastating in their own right due to the toll on human life and essential infrastructure for both countries, the flow on effect for other nations, including Australia is yet to be felt.

But the resulting economic ripple will be very real and has many analysts scrambling to predict exactly how it will play out locally when it comes to things like inflation and interest rates.

Some are suggesting that as Japan is the second-biggest buyer of Australian commodities, should its economy come to a halt demand for Australian resources would be cut, easing inflationary pressures flowing from the resources boom.

On the other hand, increased demand for Australian natural gas to repower Japan and iron ore and coking steel to rebuild its cities could intensify the boom.

Further compounding these issues are concerns surrounding fears of a major nuclear catastrophe for our Asian neighbour, with explosions at the Fukushima power station wiping 10.5% off the value of Japanese shares.

In response, Australian investors bought bonds and bank bills, pushing down yields to the point where the futures market is now pricing in zero chance of a rate rise by the end of the year and a 55% chance of a rate cut in April. However HSBC Australia economist Paul Bloxham says this is unlikely.

”Markets move quickly at times like this and quite often overreact,” said HSBC Australia economist Paul Bloxham.

”The pricing doesn’t make sense. Even with a global shock the outlook for investment in Australia is still strong. I do not expect the Reserve Bank to cut rates.”

I personally agree that the chance of a rate cut in the next twelve months is slim to none, primarily because it is more likely that recent global events will see inflation start to once again increase sooner than expected.

Let me explain…

In the first instance, initial estimates suggest that the repair bill for Japan to rebuild many of its towns and cities that were hardest hit by the earthquake and tsunami could run as high as $250 billion.

In order to cover this enormous cost, it’s likely that Japan will be forced to repatriate some of its foreign investments – namely foreign treasury bonds. Japan has a lot of money tied up in Australian bonds in particular and if they start selling these off, it will put downward pressure on our strong Aussie dollar.

In turn, this means the price of imports would rise, including the one thing we are so reliant on in this country – energy in the form of oil.

This is where Libya’s woes are concerning for Australia’s economic outlook too. While the Middle Eeastern country only controls 2% of the world’s oil reserves, should other oil producing nations be forced to step in and take up any slack in supply, oil prices will again start to rise as demand outstrips available reserves.

All of these factors that are simply out of our control could start to play out within the next three months and if this is the case, it is highly likely we will see inflationary figures start to creep up.

Such a change in our fiscal position would see the Reserve Bank pull the interest rate lever sooner rather than later in an attempt to keep the economy in check.

And with this in mind, I believe we could be looking at an initial 0.25 basis point rise around the July/August/September period, with the potential for a further increase soon after if the RBA is still concerned about inflationary pressures. 

Essentially, while the interest rate Gods have smiled on us so far this year, the take home message for borrowers is that you cannot afford to become too complacent just yet. Why? Because those global forces that have seen our economy thrive could easily cause inflation and therefore interest rates to climb sooner than some experts think.

Watch this space!



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About

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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