How high could interest rates go?

Yesterday’s decision by the Reserve Bank of Australia to raise the official interest rate by 25 basis points to 4% is the beginning of a series of increases designed to bring monetary policy into neutral territory, economist have predicted.

The comments come after RBA governor Glenn Stevens said in a statement yesterday the economy is recovering and it is appropriate for monetary policy to return to more of an “average” level, which economists pin at about 4.75-5%.

CommSec economist Craig James said in a statement interest rates have another 35-70 basis points to move before they reach this “average” mark. He also added analyst should not look too deeply into the decision, and said that as the economy recovers, it is perfectly normal for interest rates to rise and such moves should be expected.

“The Reserve Bank has lifted the cash rate for the simple reason is that it is still too low for an economy that is getting back to normal. And if the economy continues to improve, then we can expect the Reserve Bank to lift rates further.”

“CommSec has consistently noted that the cash rate will be between 4.50-5.00% late in 2010 and there has been nothing of late to sway us from that view.”

James also added the Reserve Bank is not necessarily considering home lending when it makes its decisions, and instead places an emphasis on the activity surrounding the dollar, which now buys US90c.

Additionally, he said there should be no alarm regarding stories describing the pressure placed on home owners as a result of the decision, which should add about $47 to a $300,000 loan.

“The number of borrowers experiencing stress as a result of the latest rate hike would be extremely small. Most borrowers, as well as most lenders, have assumed substantial rate hikes into their planning and budgeting decisions.”

ANZ senior economist Shane Lee said in a statement the official cash rate should reach 4.75% by the end of the year as the economy returns to normal growth.

“Indeed, another sharp fall in the unemployment rate would probably seal a lift in the cash rate in April, especially as housing finance appears to have bounced in January.”

“So far housing credit growth has remained contained, despite strong house price growth, but the risk is that it accelerates, particularly as the labour market continues to tighten and confidence remains high.”

Housing Industry Association economist Ben Phillips said in a statement interest rates will also increase this year towards more normal levels, but said rates should not increase too quickly as to ease the pressure on first home buyers.

“Interest rate increases provide further bad news to first home buyers,” he said. “The removal of the first home buyers boost and interest rate increases in the December quarter of 2009 saw a record drop in affordability.”

Mortgage Choice spokesperson Kristy Sheppard said in a statement there will be more interest rate rises this year.

“Look at this increase as a taste of things to come for 2010,” she said.”Rates are expected to continue to rise in coming months, so make sure you’re ready for higher repayments unless you fix your interest rate at a premium,” she said.

TD Securities strategist Roland Randall has also said the RBA will continue to lift rates until a more normal rate of 5.25% has been reached by the end of this year.

Stevens himself said in a statement rises should be expected.

“Interest rates to most borrowers remain lower than average… The board judges that, with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. [The] decision is a further step in that process.”

But the rise has not been welcomed by some industry groups. Australian Industry Group Heather Ridout said in a statement the decision will be hard on struggling businesses, especially if more rises occur this year.

“While today’s interest rate decision is a vote of confidence in the economy it will be a setback for many businesses, particularly those experiencing the impact of the higher dollar and patchy demand. The simultaneous withdrawal of monetary and fiscal stimulus will certainly test, over the months ahead, whether economic recovery is self sustained.”

“The RBA has banked a percentage point in rate rises plus more if market rate increases are taken into account. It should tread warily going forward as the death of the GFC may be greatly exaggerated.”

Additionally, the Australian Retailers Association called out against the rise, with executive director Russell Zimmerman saying retailers will be hurting after a fairly slow Christmas.

“Last month the RBA showed a wise and patient strategy by keeping interest rates on hold, but now it seems this approach has been replaced with a hasty decision and one that is out of touch with normal family financial cycles.”

“Retailers also have wage bill pressures from the Modern Retail Award changes from July 1 and the Minimum Wage setting decision is expected to further add to this pressure. Retailers are warning the RBA to take a cautionary approach to future interest rate decisions that have a direct and real impact on retailers who are trying to hold onto staff.”

The Reserve Bank will meet again on Tuesday, April 6.