RBA lifts rates – and more could be on the way

The Reserve Bank of Australia has lifted interest rates by 0.25% and pointed to strong economic conditions that could mean more rises are on the way.

The decision lifts the RBA’s cash rate to 6.75% and will mean an extra $68 per month on an average $400,000 mortgage.

Today’s widely expected rate rise is accompanied by a statement from RBA Governor Glenn Stevens that is unequivocal in its description of an economy operating at the limits of its capacity.

“During 2007, the pace of growth of demand and output has also increased. There are few signs of that strength diminishing as yet, and reports of high capacity usage and shortages of suitable labour persist,” he said.

Stevens also noted that while some nervousness remains about the prospect of further volatility in international financial markets due to the US sub-prime crisis, this was unlikely to seriously hamper either global or Australian economic growth.

Commonwealth Bank senior economist John Peters says the statement suggests the RBA sees all the risks to the economy being on the side of too much growth, rather than not enough.

“It’s a hawkish statement that signals they’ve got a pretty firm tightening bias in place,” Peters says. “It points to stimulus coming from all corners; high capacity utilisation, consumers are spending, lowest unemployment in three decades, governments are spending as well, and new dwelling investment has started to become a positive factor and will make a bigger contribution as time goes on.”

The RBA has also notched up its forecast for inflation in 2008. According to Stevens, both headline and underlying measures of inflation are likely to top an annual rate of 3% by the March 2008 quarter, an upgrade on the RBA’s August predictions that inflation was due to peak at around 3% annually in June 2008.

ANZ head of Australian economics Tony Pearson raises concerns that the continuing strength of the economy has caught the RBA by surprise. “The upward revision to the inflation forecasts to above the top of the target band is of concern as it suggests the Reserve Bank is ‘getting behind the curve’ in controlling inflation,” Pearson says.

The key question now is not if there will be another rate rise, but when.

Westpac Bank, which is predicting the RBA to follow up with another hike next month, sees support for its view in today’s statement.

“We believe that the sentiment in this statement is consistent with another move on rates sooner rather than later,” Westpac chief economist Bill Evans says. “To have discounted that possibility, a more pessimistic assessment of global growth and domestic credit conditions, or some specific evidence of a demand slowdown would have needed to have been discussed.”

And for those, like the Commonwealth Bank, who believe the RBA will wait to have a look at January’s CPI figures before moving again, there is reason to pause for thought.

“The pattern over the years has been they’ll move after a high CPI and we still think they’ll move again in February, but it’s not a zero chance of a move before then – they’ve moved twice in the last three months so there is a real risk they’ll move again,” the bank’s John Peters says.