Higher Interest Rates Ahead?

Is the Reserve Bank considering lifting interest rates? Its deputy governor, Glenn Stevens, hinted at the bank’s concerns in a speech last night. He said: "The issue before us in the next year or two is whether the world and Australian economies can adapt to higher energy and resource prices without a significant bout of inflation."
This suggests that the next big issue for the bank will be the producer price index on 24 October and the consumer price index two days later. High outcomes on these indicators are likely to prompt the Reserve Bank to lay the groundwork for higher interest rates in the months ahead. A lowish result will see the RBA sit tight for a while longer. In the near term, there seems no scope for a rate cut.

In a brief update on the economic outlook, Stevens focused on the themes of the world economy, energy prices, Australia's terms of trade and the housing market. He suggested that 2005 “is turning out to be another pretty good one for global growth '¦ at this point 2006 is thought likely to be another good year”.

"What is remarkable is that the rise in raw materials prices over several years has not already pushed inflation rates up more than it has." The high oil prices "imparts a mild contractionary impact on (global) aggregate demand".

On monetary policy and oil prices, Stevens noted that, "traditionally, policy-makers have abstracted from the effects of short-term fluctuations in oil prices '¦ but where there is a persistent trend for some particular price to rise quickly over a longish period because demand is strong, the case for ignoring that is weak."

On Australia's booming terms of trade, he suggested that "there is a major positive side for the Australian economy in higher prices for energy and raw materials '¦ times are very good indeed. A 25% gain (in the terms of trade) equates to about 4–5% of GDP '” say $40 billion '” in additional annual income '¦ This adds considerable buoyancy to the economy."

On housing, Stevens noted: "The rate of growth of outstanding credit remains, if anything, somewhat higher than one would expect to be a sustainable pace in the long run." On inflation, he suggested "that the question to be asked is whether inflation '¦ is likely to diverge persistently from a rate of 2–3%".

Tantalisingly, he added: "The Bank will publish its updated assessment in its Statement on Monetary Policy on 7 November." All told, it's rates on hold for a further month or two and data watching to see which way inflation pressures go.

Stephen Koukoulas is chief strategist, Asia Pacific at TD Securities.