Whoosh! Interest rates are set to increase

Wed, 05 Mar 2014  |  

Whoosh!

Did you hear that noise?

It was the sound of the Australian lifting a gear and moving back to trend growth.

The national accounts confirmed the Australian economy ending 2013 with GDP growth at a decent 2.8 per cent which translates to an annualised rate of 3 per cent over the final six months of the year.

If you were a policy maker and seeing GDP growth at trend, with inflation jumping to the upper part of your target, when the world economy is lifting, would you consider a record low 2.5 per cent cash rate to be appropriate?

You may, but not for long. In the short term, 2.5 per cent interest rates may be acceptable given the fact the unemployment rate has crept up over the past year, but this is the only thing standing in the way of the RBA starting the monetary policy tightening cycle.

With the economic indicators released since the end of December on fire, you would conclude that monetary policy must be moved towards neutral if you are to avoid a more troublesome inflation break out down the track. This is especially the case with the Australian dollar also undervalued and with signs commodity prices are moving higher. A neutral cash rate in the current global circumstances is probably 3.5 to 4 per cent.

Think about it all.

  • Inflation and now GDP growth ended 2013 much higher that you were thinking when you set the cash rate at 2.5 per cent. Much stronger.
  • Add to that the undeniable fact that the bulk of the early indicators for 2014 are strong or very strong.
  • Building approvals at record highs.
  • ANZ job ads jumped over 5 per cent in February to signal a turn in the labour market.
  • Share prices have increased to a six year high.
  • Commodity prices up over 10 per cent (USD terms) since January.
  • House price growth is rampaging at an annual rate of 10 per cent.
  • Exports running faster than Usain Bolt.
  • Consumer demand back at a trend level and likely to kick higher on the back of the record level of wealth that is being delivered by the stock market rise and house price boom. After all, the rise in house and stock prices over the past 18 months has added almost $1 trillion to household wealth.

And so it goes.

The RBA must be delighted to have been wrong with its gloomy view but must now start laying the ground work for an interest rate hike in the not too distant future. My judgment is that the RBA should be hiking rates now, but having not softened the market for such a move, it might take a month or two to convince the die-hard pessimists that such a move is needed. Hence the call from Market Economics for an interest rate hike in May or June and then a 25 basis point moves roughly every three months after that for the next year.

Which means these are the other forecasts for Market Economics for 2014 are:

GDP growth to reach 3.8 per cent through the year.

The unemployment rate to be near 5.5 per cent by year end.

Inflation to hover around 3 per cent and it could exceed it if the RBA dilly-dallies on rate hikes.

The cash rate to reach 3.25 per cent by year end and 3.75 per cent in the middle of 2015.

The Australian dollar to easily exceed 95 US cents and could test 100 if the global growth scenario has any upside surprises.

ASX to hit 6,000, quite easily as company profits roll in.

For the budget, expect to see the deficits in 2014-15 and beyond at least $10 billion a year smaller simply due to parameter changes. What the government does on the policy front should see it forecast a surplus in 2016-17.

 

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For many people, the cost of the fires is immeasurable. 

Or irrelevant. 

They have lost loved ones, precious possessions, businesses and dreams and for these people, what lies ahead is bleak.

Life has changed forever.

As the fires continue to ravage through huge tracts of land, destroying yet more houses, more property, incinerating livestock herds, hundreds of millions of wildlife, birds and burning millions of hectares of forests, it is important to think about the plans for what lies ahead.

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