Monday, 11 February 2008

RBA Signals More Rate Rises To Come

If there were any hopes that the RBA was done raising interest rates after last week's hike to 7.00%, it would seem they have diminished markedly after the bank's quarterly statement on monetary policy today. The RBA lifted its underlying inflation forecast for 2008 and warned of further interest rate rises. More specifically the RBA stated that:

In the short term, inflation as measured on a year-ended basis is likely to increase further, reflecting in part the quarterly pattern of price increases that have already occurred. Given the current strength of domestic demand and pressures on capacity, a significant moderation in demand will be needed if inflation is to be satisfactorily reduced over time.

On the current outlook, then, and allowing for the inevitable uncertainties in forecasting, the risk of inflation remaining uncomfortably high for some time is considerable. Absent a further shift in economic risks to the downside, therefore, monetary policy is likely to need to be tighter in the period ahead.

In light of the hawkish comments the stockmarket sold off sharply and the SFE March Futures contract jumped from a 30% chance of a rate rise to 7.25% at the RBA's March meeting to 69% at the close today.

Clearly higher interest rates don't bode well for the stockmarket as the return on risk free assets becomes more attractive vis-a-vis stocks. In reading the whole statement, (click on the link above for the complete statement) the bank does acknowledge that slowing global economic growth could reduce the inflation outlook faster than they currently anticipate.

If a much slower global economy were to emerge, the RBA runs the risk of being too restrictive by continuing to raise interest rates. At some point the incentive to borrow by both businesses and households evaporates as the cost of capital increases and as demand abates. The Australian economy is not yet at that point but we are certainly getting closer.