Bubble risk: Rates set to rise, RBA says
March 25, 2010 - 10:32AM
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Interest rates are set to continue rising towards more normal levels and waiting for the global outlook to become clearer runs the risk of moving too late to contain inflation, a top central banker said today.
Reserve Bank of Australia assistant governor Philip Lowe remained upbeat on the outlook for Australia, citing a significant rise in the terms of trade expected this year. This was one reason the central bank expected the Australian dollar would be higher than the average of the past decade.
But he also issued the clearest warning yet against a speculative bubble in home prices, saying the recent price rises risked turning into a speculative bubble that would be "unhelpful".
The property bubble: it's here already
Rising home prices have been one reason the central bank has hiked interest rates four times since October, a far more aggressive unwinding of stimulus than any other country.
The Australian dollar duly rallied after his hawkish speech while bill futures slid as investors revised up the chance of a rise in the 4.0 per cent cash rate as early as next month.
His confidence helped the Australian dollar pare early losses and rise a quarter of a US cent to $US0.9110. It had slipped overnight when a Fitch downgrade of Portugal stirred fesh worries of debt contagion in the euro zone.
"The RBA remains very upbeat and that means a rate hike in April is more likely than not," said Rory Robertson, interest rates strategist at Macquarie.
The central bank has already lifted rates by a full percentage point in six months and the market was now implying a 57 per cent probability of a move to 4.25 percent at the next policy meeting on April 6, up from below 50 per cent before the speech.
That was a marked swing from a 25 percent probability early this month and came despite escalating concerns about sovereign debt in the euro zone which had tempered the global appetite for risk.
Some analysts had thought the angst over debt abroad might deter the RBA from moving at home, but Mr Lowe seemed to think otherwise.
"The alternative of waiting to see how the myriad of risks evolves before adjusting policy runs the significant downside of moving too late, particularly given that the economy is starting this upswing with less spare capacity than in previous upswings," Mr Lowe said.
He alsso pointed to a number of challenges globally, including the need for some indebted countries to tighten their belts, the need for Asian countries to promote domestic demand and the likelihood that higher interest rates in Asia would suck in capital putting upward pressure on asset prices and currencies.
All these posed risks to the RBA's positive outlook for Australia but that had not stopped it lifting rates.
"The alternative of waiting to see how the myriad of risks evolves before adjusting policy runs the significant downside of moving too late, particularly given that the economy is starting this upswing with less spare capacity than in previous upswings," Mr Lowe said in a speech to an industry conference.
Mr Lowe noted recent domestic data had been firm, with employment growth robust, business and consumer confidence above average, the housing market strong and signs that businesses were borrowing again.
"Collectively, these outcomes provide us with some confidence that the economy is now in a reasonably solid upswing," he said.
Sharp increase in prices for coal and iron ore, Australia's two biggest export earners, would deliver a significant rise in the country's terms of trade.
This was a boon to business investment, the government's budget position, asset values, overall confidence in the economy and the growth of domestic incomes.
Mr Lowe noted the housing market had been very buoyant with auction clearance rates high and measures of home prices rising by around 1 per cent a month. There were a few signs the market might be cooling, and a pick-up in home construction would help somewhat. Banks were also tending to tighten lending standards rather than loosen them.
"This is good news, as it would obviously be unhelpful if a speculative cycle were to emerge on the back of the recent strength in housing prices," Mr Lowe cautioned. "This is an area that lenders and current and prospective home owners will need to watch carefully over the months ahead."
Mr Lowe said underlying inflation still looked like slowing to around 2.5 per cent this year, from 3.2 per cent last quarter.
"In addition, the Reserve Bank's liaison with retailers suggests that there has been significant discounting recently, and business surveys point to below average price increases."
Expanding the supply side of the economy and easing bottlenecks would help keep inflation anchored, he added.
"In addition, as the Bank has noted a number of times, with the economy having relatively limited spare capacity, it is likely that interest rates will need to continue their gradual move towards more normal levels," said Mr Lowe.