Inflation outlook points to rate rises24/12/2007 10:36AM AEST Interest rates are expected to rise again early in 2008, as the central bank continues to battle rising inflationary pressures, after two hikes in 2007.
Economists are tipping a rates rise as early as February, following the release of consumer price index (CPI) figures in January.
But they also expect the Reserve Bank of Australia (RBA) to tread carefully on monetary policy, given the risk of a recession in the US in 2008 and the potential for money market rates to remain high in the face of tighter conditions in wholesale money markets.
Official interest rates hit an 11-year high of 6.75 per cent in November, as the RBA sought to temper inflationary pressures amid a tight labour market and buoyant consumer demand.
The November hike was the 10th since the RBA began tightening monetary policy in May 2002.
Significantly, it also marked the first time rates were been raised during a federal election campaign.
Having stayed on the sidelines in December and with no board meeting scheduled for January, the central bank is widely expected to move again in February.
The consensus amongst economists follows the decision by the RBA to embark on a new era of transparency about its policy deliberations, bringing it into line with other central banks around the world.
The new regime began on December 18, when the RBA published the minutes of its December 4 board meeting.
The minutes revealed that a rate hike could have occurred in December, if not for the fallout from the global credit crunch which pushed up wholesale interest rates.
JP Morgan chief economist Stephen Walters said the minutes signalled a rate hike was likely in February.
"In fact, in the wake of the release of the minutes, we are more comfortable with this view than before," he said.
Mr Walters said core inflation in coming quarters was likely to be close to 3.5 per cent in annualised terms, well above the central bank's comfort zone of between two to three per cent.
"It is clear the domestic economy retains considerable momentum, so resources will remain stretched for some time to come," he said.
"Also, as the minutes indicate, the terms of trade remains a significant source of support for domestic income, and the global macroeconomic backdrop remains supportive of further growth in Australian export volumes and prices, even though we agree that GDP (gross domestic product) growth will be weaker in the near term."
There are, however, a number of factors that might give the RBA reason to hesitate.
"There is a risk that global economic growth will be weaker that we currently forecast - already we estimate a 35 per cent probability of recession in the US," Mr Walters said.
"Also, the problems in credit markets have intensified since the December board meeting, which may prompt the RBA officials to tread more cautiously than they would otherwise."
"At this stage though, the inflation outlook looks sufficiently bleak to justify an early February tightening."
A rate rise in February would take the official cash rate to seven per cent for the first time since November 1996.
ANZ group chief economist Saul Eslake said the December quarter CPI outcome was crucial.
The CPI will be published on January 23, the birthday of RBA governor Glenn Stephens.
ANZ has forecast underlying inflation to rise by one per cent over the three months ended December 31, which "would be an argument for raising rates again".
But Mr Eslake said the central bank might also be prevented from hiking if credit market tightness continues.
"If the pressure on funding costs continues, and Australian banks are not immune from that ... then again the Reserve Bank is less likely to raise rates," he said.
"At the moment, our forecast is they will raise rates in February, but it's a forecast which could easily change depending on those factors."
While most economists believe the RBA will hike in February, others believe the jury is still out.
Lehman Brothers Australia chief economist Stephen Roberts said the lagged effect of the two hikes in 2007 are likely to temper household spending in the second half of 2008.
Mr Robert noted that interest payments as a proportion of annual household disposable income is at a record high of 11.9 per cent.
"They will soon be stretched further by the equivalent of a de facto additional rate hike as lenders pass through higher funding costs resulting from the widening of credit spreads since August," he said.
"We expect CPI inflation to rise a little above the top of the Reserve Bank's two-three per cent target band in (the first half of) 2008, but to push lower later in 2008 and in 2009 as demand-side pressures moderate, tempering employment growth and capping wage pressures."
"We think there will be sufficient evidence of downside risks to global growth early in 2008 to stay the bank's hand."
