Economists back RBA interest rates pause, but say more hikes to come

The impact of the debt crisis in Europe and fears of high inflation caused the Reserve Bank of Australia to keep the official interest rate steady at 4.5%, economist say, but opinions are mixed as to whether another rise is on the cards next month.

The comments come as businesses breathed a collective sigh of relief yesterday after the RBA paused for the first time in four months to weigh up the new economic environment following Europe’s debt breakdown.

The pause was expected by economists, who have said over the past few weeks economic data including consumer confidence and weak retail sales pointed to a pause.

TD Securities senior strategist Annette Beacher said in a statement the RBA is likely to keep rates at their current rate for at least one more month.

“Clearly the RBA is comfortable with the heavy lifting done to revert to average, but a shift to restrictive policy will be on the RBA agenda as inflation pressures are building,” she said.

“However, future policy adjustment will be data dependent locally and calmer markets need to prevail offshore.”

CommSec economist Craig James noted the RBA statement was uncharacteristically short, and makes no reference to housing prices, consumer spending or the labour market, effectively leaving economists in the dark. But the result of the pause means that consumers can now have time to adjust to the previous rate rises.

“Aussie consumers and businesses are understandably shell-shocked and now need a little time to adjust to the new financial environment. So the hope is that this time around the pause in rates last longer than one month.”

However, James said there is no certainty as to how long rates will remain on hold, saying even the RBA itself could be struggling to make sense of the current economic environment.

“The six-month overnight indexed swap rate is as good as any indicator in providing views on the interest rate outlook. And at present the pricing points to no change in cash rates until much later in the year.”

James also noted borrowers should factor in rate increases of up to half a percent later in the year, “but in the current environment this appears more of an upside risk”.

“As we have seen over the past two months, the environment can effectively turn on a dime. The optimism that was in abundance in mid-April has now given way to fear and uncertainty with investment markets increasingly skittish.”

However, ANZ economist Katie Dean said in a release the next movement for interest rates is likely to be “up, not down”, despite risks of high inflation and impacts from Europe.

“Our forecast is for two further interest rate rises, of 25bp a piece in Q3 and Q4 this year. This is predicated on the view that global growth stays around trend this year and that Australian contract commodity prices continue to rise (albeit at slower rates) over 2010-11, fuelling domestic inflationary pressures in our capacity-constrained economy.”

“Having outlined a neutral bias, the RBA now has sufficient flexibility should global conditions worsen or domestic conditions strengthen. We continue to believe the next move in interest rates will be up, not down.”

The only risk, Dean said, is that the RBA may stay on the sidelines for an extended period in order to weigh up just how much damage the global economy has taken from the European debt crisis. Moving rates to a neutral level has given the RBA scope to respond to any type of economic environment.

The risks from both the European debt crisis and government attempts to slow an overheating Chinese economy will not be resolved quickly… These risks could keep the RBA on hold well into year-end.

Westpac economist Bill Evans also noted the next movement for interest rates will be a rise, saying that even though the RBA intends to take in the new financial environment, inflation poses a significant risk.

“We were surprised that the concluding sentence did not just finish with “setting of monetary policy as appropriate” – there was an additional qualification “for the near-term”. Note that markets currently “assess the probability of a movement either way in rates out to April 2011 as being less than 50%.”

Evans said he interprets this comment as “hawkish”, and that it implies the RBA believes there was too much complacency that rates would be held at neutral levels when labour markets are tightening along with growing inflation.

“While developments in the global financial markets will be of paramount significance over the next two months, we are still worried about the next inflation print on July 28, and on balance expect that another rate hike of 25bp is the most likely outcome.”