OECD predicts Australian interest rates will soar, but economists aren’t buying it

The organisation of economic coordination and development has forecast Australian interest rates will reach 5.7% within a year, pushing up variable mortgage rates and increasing pressure on financially-stressed home owners.

If the predictions come to pass, it would mean Australia’s interest rate would be one of the highest in the world at a time when more countries are keeping rates low as their economies recover from the global financial crisis.

The OECD’s Economic Outlook, released in Paris yesterday, predict Australia’s interest rate will rise from its current level of 4.5% to 5.7% during mid-2011, as the Reserve Bank attempts to combat inflation.

Indeed, the RBA’s latest forecasts indicate inflation will remain towards the upper-end of its 2-3% target band during the remainder of the year, and during 2011.

However, an increase in interest rates would put further strain on home owners, who are already feeling pressured as interest rates continue to rise. The extra 120-points predicted by the OECD would add about $200 to a monthly home loan with a $300,000 mortgage, on average.

Variable mortgage rates would rise well above 8%, reaching as high as 8.6%, above the level economists consider to the point at which consumer confidence takes a hit.

But the OECD says Australia’s economy is so resilient, the RBA will continue to raise rates in order to combat inflation.

”The business climate and business confidence are strong. Firms have significantly expanded their investment plans, particularly in the mining sector, where strong demand from Asian countries has led to marked improvement in the terms of trade and higher profits.”

But some economists have said consumer confidence is already taking a beating.

Just two weeks ago, Westpac economist Bill Evans said consumer confidence is at a crucial point. If interest rates rise any further, sentiment will plunge which could have huge effects on the overall economy.

“We have written in the past about sensitivity points for mortgage rates above which sentiment can be damaged quite substantially,” Evans said, adding that point has now been reached.

“In the last rate hike cycle that point was reached in March 2005 when the mortgage rate was increased from 7.05% to 7.3%.”

But contrary to the OECD’s report, Evans said he expects the RBA to pause given the effect interest rates have had on consumer confidence and sustained economic recovery.

The OECD even commented on this activity, saying that “The current tightening of monetary and fiscal policy is welcome given the rebound in activity”.

But CommSec economist Craig James believes the OECD report isn’t necessary accurate, and doesn’t expect rates to reach as high as 5.7% next year.

“I think it takes a long time for these reports to go out, and there are a lot of factors that have affected the economy in that process, such as what’s happened in Europe and so on. The market view now is that the RBA could be on hold for some time.”

James says there should be another 50 basis points added to the current interest rate this year, with another 50 added during 2011 – somewhat slower than the pace predicted by the OECD.

“This year, businesses just don’t want to spend. We’ve been a bit shell-shocked globally and with the RBA raising interest rates so quickly, and so while the OECD report gives a good, big-picture view, it’s clear that things are changing.”

“During the period this report was compiled, there was a lot of volatility and things have changed. It’s also a little bit of a misreading about how strong consumer and business spending is, which will still be recovering over time.”

James says he believes the RBA will pause interest rate rises, as this will give them “greater flexibility” to move either way if the economy does not recover as planned.”