Australian interest rates will continue to rise to more normal levels despite global jitters as holding off with increases risks falling behind on inflation, a top central banker said on Thursday. Reserve Bank of Australia (RBA) Assistant Governor Philip Lowe also issued the clearest warning yet against a speculative bubble in home prices, while welcoming a higher local dollar as part of boom in the country's terms of trade.
The Australian dollar duly rallied after his hawkish speech while bill futures slid as investors revised up the chance of a rise in the 4.0 percent cash rate as early as next month. "The RBA remains very upbeat and that means a rate hike in April is more likely than not," said Rory Robertson, interest rates strategist at Macquarie.
The central bank has already lifted rates by a full percentage point in six months and the market was now implying a 57 percent probability of a move to 4.25 percent at the next policy meeting on April 6. That was a marked swing from a 25 percent probability early this month and came despite escalating concerns about sovereign debt in the euro zone, which had tempered the global appetite for risk.
Some analysts had thought the angst over debt abroad might deter the RBA from moving at home, but Lowe seemed to think otherwise. "The alternative of waiting to see how the myriad of risks evolves before adjusting policy runs the significant downside of moving too late, particularly given that the economy is starting this upswing with less spare capacity than in previous upswings," Lowe said in a speech to an industry conference.
His confidence helped the Australian dollar pare early losses and rise a quarter of a US cent to $0.9110. It had slipped overnight when a Fitch downgrade of Portugal stirred fesh worries of debt contagion in the euro zone.
TRADE BOOM MEANS STRONG CURRENCY The local currency remained near record highs against the euro and a 25-year peak against sterling. Indeed, Lowe said it was now widely accepted that the Australian dollar would probably remain relatively high over the next few years, making the RBA almost alone among central banks in welcoming a strong currency.
Lowe did concede there were risks abroad, including high levels of debt in some advanced countries, but argued the most likely outcome for Australia was of continued growth fuelled by Asian appetite for its resource exports. Strong demand for iron ore, particularly from China, meant prices could rise around 90 percent this year, with coal not far behind. Iron ore and coal are Australia's two biggest export earners, while trade with China had ballooned in recent years to top A$80 billion ($73 billion).
Lowe said such price rises would deliver a significant boost to Australia's terms of trade - what it gets for its exports compared to what it pays for imports. This would be a boon to business investment, the government's budget position, asset values, overall confidence in the economy and the growth of domestic incomes.
The resilience of incomes was also highlighted in the RBA's semi-annual review of the financial system, which argued that households and firms were coping with higher rates well. In particular, household net worth had climbed around 11 percent in 2009 to stand at A$610,000 per household. The RBA was less happy that the boom in economic activity was already driving home prices higher, with some measures recently rising by 1 percent a month.
"It would obviously be unhelpful if a speculative cycle were to emerge on the back of the recent strength in housing prices," Lowe said. "This is an area that lenders and current and prospective home owners will need to watch carefully." David de Garis, a senior economist at NAB, thought this "a blunt warning" on home prices. "In other words, more rate rises would be in the offing," he said.