Property News

Another rate rise tipped

12 October 2006

New Reserve Bank governor Glenn Stevens says interest rates are more likely to rise than fall, after warning the nation cannot allow the high inflation of the past year to continue.

In his first speech since his appointment last month, Mr Stevens said his main job was to resist the inflationary pressure that had recently developed in the economy, pushing prices up an annualised rate of 4 per cent in June.

He said the Reserve Bank could lose its ability to respond to future economic crises if people started to expect inflation rates above 3 per cent.

"Acting as needed to keep inflation in check in the near term, on the other hand, preserves future flexibility," he told a meeting of business economists in Sydney last night. "If we can successfully see off the higher inflation of the past year or so, we will have done a lot to establish the conditions needed for ongoing growth."

After the speech, he said: 'Some months ago, when we were asked, we said rates were more likely to rise than to fall, and I would say this is still the case."

ANZ treasury economist Warren Hogan said it was a "defining speech" from the new governor. "He made it very clear that he's got an inflation focus," he said.

Mr Stevens said further rises would depend on the inflation figures for the September quarter, which will be released in two weeks.

He said the Reserve Bank would take account of the delayed effect of the two rate rises it has ordered so far this year. However, his comments are likely to change the financial markets' view about the likelihood of a third rate rise at the bank's next meeting on November 7.

The weakness in the US economy had led financial markets to lower the probability of another rate rise from 70per cent to less than 30 per cent over the past two months.

Another increase would raise the cash rate to 6.25 per cent and could push standard mortgage rates to 8 per cent.

The Reserve is puzzled by the apparent weakness of economic growth at a time when both employment and the Government's tax revenues are growing strongly. Mr Stevens said the year's fall in unemployment would normally suggest the economy was growing at a rate of 3 per cent or more, not the 2 per cent officially reported.

If the official GDP figures were wrong and the economy was growing more quickly, then inflation was likely to rise.

Mr Stevens said this would explain the strength of employment and government tax revenue. But if the employment figures were wrong, and the economy was actually growing more slowly, it might mean there was more spare capacity in the economy and inflation would fall.

"An economy with genuinely sub-potential growth over two years ought, other things being equal, to start putting some downward pressure on inflation fairly soon," he said.

The third and most worrisome possibility is that both economic growth and employment figures are right, which would suggest a dramatic fall in productivity. This would be bad for inflation and would require higher rates to slow economic growth even further.