Are Aussie interest rates about to hike?

There is a slowly growing vibe that the next move in interest rates in Australia will be up. Perplexingly, money markets are starting to price in higher interest rates for reasons that are paying scant regard to local economic news.

It is a case of the local market reverting to its unthinking, unquestioning attitude to what the RBA tells them in private “Chatham House rule” meetings plus the lead from the US where its strong economy will see the Fed hike its interest rates a few times over the next six months.

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In Australia and for the RBA, it is an approach that is ignoring a litany of weak economic indicators.

Think about this for a moment for the Australian economic scorecard. Private sector business investment is in free-fall to be down 13 per cent in the last year and 33 per cent in three years. Underlying inflation is the lowest ever recorded and has been below the bottom of the RBA target range for over a year. Wagers growth has slipped below 2 per cent which is the weakest wages growth in many decades. Employment growth has stalled and underemployment is at a record high.

Making the scenario of steady interest all the more problematic is the resilience of the Australian dollar which is being underpinned by current interest rate settings which has Australia one of the highest interest rate countries in the industrialised world. As a result, money continues to flood into Australia to underpin the Aussie dollar.

Also read: Weaker foreign demand is about to hit Sydney's apartment market

It seems the RBA and the market have ants in their collective pants about the possibility of higher house prices if interest rates were cut further. This ignores a couple of vital issues. Mortgage interest rates are already rising on the back of the rise in bank funding costs so a cut in official interest rates would at least partly reverse some of that pressure just when the economy needs it.

As noted, house prices are poised to weaken, perhaps even fall sharply, as the glut of property hits the market and investor demand falters. The fresh supply of housing will have a more significant dampening effect on dwelling prices than a small fall in interest rates. Thinking a rate cut from the RBA would underpin house prices is to ignore the other drivers of house prices.

Perhaps most importantly, it is the business sector that would be a significant beneficiary of lower interest rates with cash flows freed up on existing debt and the hurdle to borrow more for much needed investment lowered.

The economy is not disasterously weak, but it needs an injection of policy stimulus and interest rates can be cut quickly and easily and the RBA should simply do it.

Also read: Is Australia suffering from a two-speed economy?

It costs nothing, the global economy is hardly poised for an inflation break out and the risk that Australia’s inflation rate will skyrocket anywhere near the top of the RBA target band on a rate cut of even t50 basis points is fanciful.

A cold hard look at economic facts screams lower interest rates are needed. A convoluted, model based rose coloured forecasting strategy says rates should be on hold.

The RBA needs to put its fancy model aside for now and get into the real world and cut interest rates – and do it soon. RBA, your country needs you.

 

 

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks, and as economic advisor to the Prime Minister of Australia.