Australia: Another Rate Hike, But Are The Reasons Sound?
While I had not been pencilling in another interest rate hike this year, the Reserve Bank Of Australia (RBA)’s decision to raise its policy rate by 25 basis points (bps) for a third consecutive month to 3.75% on Tuesday was not wholly unexpected. Indeed, Business Monitor Online stated on November 30 that the risks were skewed to the upside given recent hawkish rhetoric by RBA Governor Glenn Stevens.
From a fundamental standpoint, my colleagues and I continue to believe that Australia’s monetary authorities may be tightening policy for the wrong reasons. Higher interest rates can, of course, be justified in light of growing bubble risks (house prices have smashed through 2008′s all-time highs, and are up 10% on the year). However, the House view is that the RBA’s aggressive actions are predicated on a misplaced belief that the economy is out of the woods. [Click chart below to enlarge]
On the contrary, I am concerned that private consumption could falter as higher interest rates are passed on to Australia’s overleveraged consumer (private debt stands at over 160% of GDP). Meanwhile, growing risks of a Chinese monetary and fiscal tightening in the second half of 2010 could yet knock Australian exports off course.
For these reasons, I would caution that some of the RBA’s rate hikes could be unwound down the road, and thus I hold onto BMI’s ‘receive fixed-pay floating’ position on the 8×11 forward rate agreement (FRA) – a viewthat has already gone 34bps in our favour since initiation on November 3.
December 1st, 2009 at 6:31 pm
Surely private debt at 160% of GDP is reason enough for credit markets to be tightened! Keeping monetary pol loose will only exacerbate the risks that this level of leverage poses to the economy. Am I missing something here?
December 1st, 2009 at 6:44 pm
In fact, you’re absolutely correct! I’m not saying they should not hike. What I am saying is that the RBA seems unaware of the consequences of such rate hikes, and so is likely to reverse them when the consequences are felt. The RBA seems to believe that the economy has escaped a sharp recession due to ‘confidence’, and thinks that the boom will continue for years. The reason for the recent outperformance is leverage.