Insolvency Experts

Markets expect rates to rise - Sydney Morning Herald 11-6-08

GLOBALLY, interest rates look set to go higher, but the case is strong in Australia for the Reserve Bank to stay on hold.

The financial markets fully expect the RBA will order a rise by the end of the year to push the official cash rate to 7.5%. The chance of a move in August, after the next consumer price index number, is at 64%.

The expectation has rallied strongly in the past two trading sessions, with the view now being that there could be two increases of 25 basis points each in the next year. This outlook seems remarkably bullish given there is no doubt that the Australian economy is cooling. The bills and bond markets are reacting to the US.

US Federal Reserve chairman Ben Bernanke has raised the prospect that the aggressive rate cutting cycle that began as the credit crunch started could soon have reached its peak.

The comments provoked a big sell-down in the US treasury markets: the yield on the two-year government note rose by as much as 30 basis points at one stage. A shift of that size indicates the market is now ready for rate rises in the US.

It's a similar story in Europe. The market had been forecasting further cuts in the eurozone until European Central Bank boss Jean-Claude Trichet admitted a July rate rise could be a reality.

The changed outlooks in the US and Europe come at a time of global high inflation. The soaring price of oil will feed through to higher prices, both wholesale and for consumers, across the board. In the US, the inflation outlook is already worrying.

Australia is not immune to the oil effects. Inflation here is already high and the RBA is banking on its strategy of bringing down inflation by moderating demand growth in the economy.

From the signals so far from Glenn Stevens, the Reserve Bank is in a mode of data dependency, as it should be. The economy is slowing; it's just a question of whether it is enough. The biggest threat to rates in Australia will be wages. If there is a wages breakout, the RBA could go.

So far wages have been under control, but there are a number of union claims at the moment that could threaten this stability.

The unemployment number on Thursday should remain steady at 4.2%, but, if there is a sharp shift down coupled with higher wages, then rates could be put up. But at this stage, financial conditions are tight enough in Australia to persuade the RBA to keep rates on hold.