Seventh rate rise in the pipeline

Borrowers may well face a further interest rate rise in the early part of 2008, that is the most likely scenario arising out of the Reserve Bank’s quarterly assessment of the economy this week – and fresh indicators underlining the buoyancy of the economy.

Core inflation is already nudging 3 per cent, the upper limit of the target band set for it, and the RBA sees it rising to 3.25 per cent in 2008, it says in its monetary policy statement. That in itself suggests the finger remains on the rates trigger as it tries to keep inflation within target over the medium term. The RBA does expect inflation to fall back below 3 per cent over the next two years anyway, but says – when balancing the risks – “it is also possible at this stage of a long economic expansion that inflation will be more difficult to contain”. This means it is leaning towards higher rates because it doesn’t want that risk – keeping inflation in check is priority number one.

Significantly, the RBA statement says that it has discounted to some extent the factors that could retard growth in the economy and help contain inflation – namely the sub-prime-inspired instability in global credit markets raising concerns about a US recession, and the two-decade high in the Australian currency against the US dollar, which works to reduce import prices. Global market conditions are now more settled and the impact of the high dollar more muted than one might expect, the statement says.

The latest Wage Cost Index for the September quarter shows wages growth of 1 per cent for an annual rate of 4.2 per cent. This means wages growth remains stronger than average but is not accelerating and, most importantly, is not hitting the RBA’s speed limit of 4.5 per cent. Wages continue to stay remarkably contained in the face of strong growth and inflationary pressures brought on by skills shortages. This is good news for borrowers. Interest rates may be uncomfortably high, but they could well be higher were it not for the more efficient labour market we have these days.

But inflation is bubbling up in the economy for other reasons, that much we know, and other indicators out his week underscore the fact. The Melbourne Institute index of inflationary expectations suggests consumers are anticipating headline inflation of 4.4 per cent. To some degree, these expectations are self-fulfilling. Consumer confidence has fallen in the aftermath of the November rate rise – but only 4.2 per cent, much lower than after previous increases. It remains 10 percentage points above the long term average, so consumers seem set to keep spending.

This is all grist for the mill in the chances of a further interest rate rise. It won’t happen in December as some have been saying, but could well be in February if the next CPI figures out in January continue the upward trend.