RBA keeps rates steady – but for how long?

Interest rates will stay at their current level of 6.5%, after the board of the Reserve Bank of Australia this morning announced the outcome of its meeting in Perth yesterday.

The “no-change” result was widely expected by economists and market participants, who felt that the RBA would adopt a wait-and-see approach in the face of continuing uncertainty in financial markets over the effect of the sub-prime mortgage meltdown in the US.

Yesterday’s strong GDP result of 0.9% for the June quarter, and 4.3% for the year, suggests that the RBA will be keeping a close eye on data over coming months for signs that the economy is overheating.

Of particular concern will be the very strong growth in wages in the June quarter. Non-farm wages increased 2.1% in the three months to June, a decade-high growth rate that suggests the lid that has been kept on wages growth over the past year may finally be beginning to pay off.

There was some good news on the inflation front from yesterday’s figures with business investment, which leapt 4.6% to an annual growth rate of 13.3%, a big figure that suggests that new capacity will come online in the year ahead and ease inflationary pressures.

The key question will be whether economic figures over coming months, culmination with the third quarter CPI data in late October, paint a picture of an economy that is growing too fast and driving inflation outside of the RBA’s 2% to 3% target band.

Most economists are predicting that the RBA will have to make a move. ANZ senior economist Riki Polygenis says rates are likely to rise in early 2008, while HSBC chief economist John Edwards say the rate rise could come as soon as November this year.

Interestingly, all this speculation about a possible further rate rise could itself be starting to have a slowing effect on the economy. The Australian Industry Group–Commonwealth Bank Performance of Services Index for August fell 4.4 points to 51.6, just above the 50 point line separating growth from contraction.

AI Group chief executive Heather Ridout says the slight decline in growth from July is attributable to the interest rate rise in August and talk of another rise to come.

“Speculation of further rate rises, as well as uncertainty in the lead up to the federal election, have also reduced business confidence. The moderation in growth was even more pronounced for the business-related sectors, such as finance and insurance; transport and storage; and communication services,” Ridout says.

Mike Preston