Interest rates on hold again – but for how long?

By Bob Wilson, 8th July 2010

Seventeen economists can't be wrong, can they? The Australian polled 17 such analysts in late May and all concluded that the Reserve Bank would hold interest rates in June. That forecast has proven correct both for June and July, with this week's announcement that the cash rate would again stay at 4.50%.

Reserve Bank Governor Glenn Stevens says the current monetary policy setting means that home mortgage rates are around the average levels of the past decade. Interest rate monitoring companies agree that this"average" variable loan rate is 7.00%, but whether borrowers consider this to be average or not depends on just how much other debt their household is carrying.

Even so, several banks have already foreshadowed mortgage rate rises independent of the RBA's back-burner move. At this stage, no bank has yet broken ranks and we can expect such a move to be politicised if they do it at all.  The next few months of interest rate deliberations should at any rate have a serious impact on polls as honeymooning PM Julia Gillard considers when to call an election.

The RBA's decision to hold rates for the second consecutive month follows six monthly rises of 0.25% since October 2009 (borrowers were given a reprieve in January and February before two more rises in March, April and May).

On that basis, should we consider these two consecutive months free of interest rate hikes as a "breather" or a sign of apolicy shift? Governor Stevens hinted that inflation was expected to be heading towards the upper end of the RBA's tolerance threshold (2% to 3 %). The RBA introduced this inflation target in 1993. In the ensuing years, inflation has tipped 4% twice and went well over 4% in the later part of the decade. No surprise that these periods coincided with higher interest rates.

Inflation data for the second quarter of 2010 is expected to be published on July 28, and this number (which could be 2.9% or more), will influence the RBA's next interest rate decision in the following week. If the rate is above 3%, then the economists who are now saying there will be no more rates rises before Christmas could well be wrong.

Interest rate monitoring website RateCity says the decision to hold is welcome relief for borrowers who have seen average monthly repayments rise by around $300 since September 2009. RateCity chief executive Damian Smith warns there is always a danger, when interest rates fall or are left on hold, for borrowers to become over-confident and over-borrow.

"This is when your repayments take up a large chunk of your income. The problem is that if interest rates start to rise again and your loan is at a variable rate, your repayments will increase, which leaves less money for other expenses."

RateCity found that the last time the RBA left rates on hold for two consecutive months (January and February), the Australian Bureau of Statistics recorded a 14% increase in the number of home loans (an extra $1.4 billion) in February compared with January. Smith says credit card balances accruing interest also increased (by $227 million), from January to February.

Canstar Cannex says expectations that interest rates will be steady in coming months have narrowed the gap between fixed and variable loan rate products. A three-year fixed rate loan has dropped to within 16 basis points of the average variable loan rate, Canstar Cannex analyst Mitchell Watson says.

The Housing Industry Association welcomed the "hold"position, saying past rate rises had dented demand and confidence. HIA chief economist Harley Dale says the decision was appropriate, given the mixed signals from the domestic economy and renewed nervousness abroad.

"Meanwhile, there remains no justification for major banks to lift interest rates independently of the RBA," Harley says. "The continuation of overly-tight lending conditions for residential development is already acting as a considerable restraint on new home building," he adds.

Not that Australia can afford to focus solely on domestic issues. Future monetary policy shifts could be influenced by deteriorating (or improving) global conditions. No doubt the global debate about stimulus versus belt-tightening must have given Governor Stevens pause  for thought. In his latest monetary policy statement he refers to the "uneven"expansion of global growth, concerns about sovereign debt in countries like Greece and Spain and a re-emergence of tightening in some funding markets. He says the July benchmark interest rate is appropriate, "pending further information about international and local conditions for demand and prices".

Westpac chief economist Bill Evans, quoted by Bloomberg, says the clear reference to "local conditions" gives Governor Stevens the flexibility to increase rates.

"Short of a further substantial deterioration in the global economy, an increase in underlying inflation rate of 0.8% in the second quarter from the previous three months will be enough to trigger another rate rise," Evans says.

ENDS