Inflation Warrants Interest Rate Rise

The Reserve Bank of Australia (RBA) today lifted official interest rate levels for the third consecutive month. Effective 5th May 2010, the cash rate will rise by an additional 25 basis points to 4.5 per cent. This is the sixth rate rise since October and will put a further strain on those who have recently entered the housing market.

This latest rate rise was not unexpected, with many economists predicting that something would need to be done to curb rising inflation levels and soaring house prices. In many ways the Australian economy is performing very well, so well in fact that many see the recent rate rise as the RBA attempting to apply the brakes to an Australian economy that may well be in danger of overheating. If inflation continues to grow strongly then more rate rises would have to be expected throughout 2010.

RBA Governor Glenn Stevens explains the reasons behind the rate rise in a statement released in conjunction with the interest rate rise announcement.

“Australia’s terms of trade are rising by more than earlier expected, and this year will probably regain the peak seen in 2008. This will add to incomes and foster a build-up in investment in the resources sector. Under these conditions, output growth over the year ahead is likely to exceed that seen last year, even though the effects of earlier expansionary policy measures will be diminishing. The process of business sector deleveraging is moderating, with business credit stabilising and indications that lenders are starting to become more willing to lend to some borrowers, though credit conditions for some sectors remain difficult. Credit outstanding for housing has been expanding at a solid pace. New loan approvals for housing have moderated over recent months as interest rates have risen and the impact of large grants to first-home buyers has tailed off. Nonetheless, at this point the market for established dwellings is still characterised by considerable buoyancy, with prices continuing to increase over recent months.

Recent data on inflation confirm that it has declined from its peak in 2008, helped by a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand. In both underlying and CPI terms, inflation over the most recent 12 months was around 3 per cent. Nonetheless, the extent of decline from here may not be quite as much as earlier forecast and inflation now appears likely to be in the upper half of the target zone over the coming year.

With the risk of serious economic contraction in Australia having passed some time ago, the Board has been adjusting the cash rate towards levels that would be consistent with interest rates to borrowers being close to the average experience over the past decade or more. The Board expects that, as a result of today’s decision, rates for most borrowers will be around average levels. This represents a significant adjustment from the very expansionary settings reached a year ago.

The Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of 2–3 per cent over time.”

If the rate rises have you concerned over your finances you should get in contact with us. Somebody from our experienced team will be able to assist you with any questions.