OPINION - A fair way down the road

It also implied that rising inflation is once again becoming a concern.

But could the Reserve Bank have left the official cash rate on hold?

Absolutely. In fact, I believe the RBA could have kept rates on hold at least until February 2011 and still managed to keep inflation in check. That said, I think the broad direction for the Board is right.

Australia is currently enjoying strong growth thanks to the resources boom. Today, Australia’s economy is more closely aligned with Asia than with that of the Americas and Europe.

Both America and Europe are currently enduring anaemic activity and, in many cases, very low inflation bordering on deflation, which is why the respective countries continue to keep interest rates at very low levels.

On the other hand, Asia is strong. The Asian economies have bounced back with relative ease. We have seen growth in these countries zoom up to approximately 10 per cent.

But, this speedy and impressive growth needs to be kept in check.

The Asian countries cannot let their growth get out of hand so they have tightened monetary policy accordingly – which is also what Australia is doing.

Australia has enjoyed solid growth over the last year. We have also seen a spike in our national income because the prices for our exports have gone through the roof.

While many Australians have not yet enjoyed the direct benefits of the national income spike because they do not work in the mining sector, it is likely they will enjoy those benefits in time as mining stocks pay higher dividends and taxes, employ more as well as invest more. In particular, increased mining sector employment will likely push wages up around Australia.

If wages increase, so could retail spending and this combined with strong mining investment would push up inflation.

While this development is still many months off, the RBA opted to lift the cash rate in November in order to offset any potential increases in inflation.

THE YEAR AHEAD

By timing its lifting of the cash rate in this way, the Board also effectively allowed Australia’s majors to move out of cycle.

As such, the RBA’s November rate decision turned out to be a little harsher than the Board had bargained for, which leads me to believe the RBA will not move again until February at the earliest.

In fact, we could even see the Board stay on hold until April, because the need to move aggressively on rates has now passed.

In a year’s time, we will probably see the cash rate head to approximately 5.5 per cent.

This will take the standard mortgage rate to 8.5 per cent. But given the public outcry against them recently I don’t expect to see the banks move out of cycle again anytime soon.

I feel that Australia’s lenders have largely recouped the funding costs they were complaining about, which removes the pressure on them to move independently of the RBA.

That said, if the problems currently plaguing Europe become broader and the banks start to face a higher level of funding costs, then they may need to lift out of cycle once again.

In my opinion, however, I don’t think the problems in Europe will escalate to this state.

Yes, they will continue to bubble away, but not to the extent that they will cause problems for the Australian banks.

I don’t expect Australia’s majors or second tier lenders to move mortgage rates until the Reserve Bank does and when this happens, I would expect the lenders to move in line with the RBA in 0.25 per cent increments.

Shane Oliver

AMP, Chief Economist