interest rates to rise faster, higher

Interest rates to rise faster, higher than expected
Karina Barrymore From: News Limited newspapers July 27, 2010 8:44AM

The RBA says tomorrow's inflation result will be a key factor in the board's next decision
INTEREST rates are tipped to rise faster and higher than expected as speculation is growing that we are facing a rates double whammy.

High inflation, coupled with a drive by the banks to shore up their profit margins, could result in interest rates being increased by the Reserve Bank and also by the banks themselves.

RBA governor Glenn Stevens says tomorrow's inflation result will be a key factor in the board's next decision.

The RBA tries to control inflation by increasing or decreasing interest rates.

It wants to keep underlying inflation between 2 and 3 per cent. It is currently at just over 3 per cent.

Commsec chief economist Craig James says the Consumer Price Index number for the June quarter will be "pivotal" to future rates.

"For underlying inflation to move back into the 2-3 per cent target band, the (CPI) result would need to be around 0.8 per cent," he says.

"Anything higher would substantially increase the odds of an August rate rise."

At the same time, however, ongoing fallout from the global financial crisis means Australian banks are being squeezed on their cost of funds.

Although Australian banks have weathered the crisis well, overseas banks are still under enormous pressure.

This means Australian banks have to pay more for the approximate 30 per cent of money they source from overseas to meet the demands of local borrowers.

LoanMarket operating officer Dean Rushton says: "It is not a matter of 'if' banks will lift their rates but 'when', because they are not only paying more for wholesale rates but paying more on deposits, which is another key area of funding."

Lenders could lift their rates independent of any RBA decision and could strike soon after the August 21 federal election, Rushton says.

"Borrowers should be prepared for rates to rise in the final quarter of 2010 because of the wholesale funding issue."

However, Commsec's James also says the RBA is aware of the potential move by the banks and is likely to want to avoid a double whammy increase.

"It is an issue on the RBA radar screen," James says.

"If banks were forced to raise rates independently, the RBA could remain on the interest rate sidelines."