Former Reserve member warns rates could rise

Most economists are tipping rates to stay on hold today, but a former Reserve Bank board member says they could rise later this year.

The board of the Reserve Bank holds it first meeting of the year later this morning in an atmosphere of relative economic calm both globally and domestically.

That has most economists tipping that the RBA will hold rates at 3 per cent to see if the stability continues.

"They'll always take the temperature of the economy but I think for where they are now, I'd say that they feel a lot more comfortable about where the world economy is," said Barclays Bank's chief Australian economist Kieran Davies.

"Domestically they do have low interest rates by past standards now, so they have done a lot." However, with potentially bullish times ahead, a former RBA board member says a rate rise is possible in the lead-up to the election in order to head off an asset price bubble.

"I think the global confidence is stabilising.

I think it's a false dawn actually, but over the next few months you'd expect the global economy to be in a fairly stable position," said ANU economics professor Warwick McKibbin, who served on the RBA board for a decade between 2001 and 2011.

"The biggest problem that most central banks face is the upward movement in asset prices, which is quite different to goods price inflation, but it's still inflation nonetheless, and having a bubble in an asset market is not a very good thing for a central bank." Professor McKibbin says that worrying rise in asset prices means a rate rise ahead of the federal election in mid-September cannot be ruled out.

"There's an enormous amount of uncertainty in the world at the moment but, I think, my guess is that a rate increase is more likely than a rate decrease between here and the end of the year, and that includes the election," he added.

'Asset bubbles' Professor McKibbin says the RBA is likely to be watching asset prices - such as real estate and shares - not only domestically, but also internationally.

"There's already asset bubbles in Asia, if you look at real estate prices in Hong Kong and Thailand, those central banks are going to have to start moving their interest rates to a more tightening position," he said.

"I think Australia is going to be watching that very closely." The Reserve Bank has ignored politics in the past, with a rate rise a few weeks out from the election in 2007, and Warwick McKibbin says he expects the current board will similarly ignore any political considerations.

"I was actually on the board in 2007 and that was a very difficult decision but, in the end, it was the national interest that matters and that's what the bank will do when the time comes," he said.

"The discussions that I've been involved with have always been in the context of what the economic situation is at home and abroad, and I think that's probably still the case." 'Potential crisis' Warwick McKibbin and most financial institution economists agree that there is still potential for rates to come down further, but it may not be cause for celebration if they do.

"There's still potential for a crisis emanating from Europe.

There's still a potential for a crisis emanating in the US over the fiscal deliberations, although that's now been pushed into the future," said Professor McKibbin.

"So there are some triggers out there for some bad news.

At the moment though I think there is a lot of good news around.

The energy boom in the US is actually starting to propel the US economy to a more sustainable growth rate." Kieran Davies agrees that risks remain.

"You can never rule out things going backwards in Europe again, so there's still the risk that interest rates need to go lower here," he said.

"But we think that, as a central case, it's rates on hold but the RBA prepared to act if need be." However, Professor McKibbin warns borrowers that, if nothing goes dramatically wrong in Europe or the US, a rate rise is very much on the cards.

"The bottom line though is that in an economy with unemployment where it is and inflation where it is, you'd expect the interest rate to be closer to the nominal growth rate, which is 5 per cent," he explained.

"And, even adjusting for risk, you still don't really have a policy that I would call a tight monetary policy in this country."

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