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Interest rates in 2017: what to expect

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By Michael Witts

What was discussed at yesterday’s RBA meeting? Were there any major differences compared with the December statement?

At today’s meeting, the RBA kept the cash rate unchanged at 1.50%. This outcome was broadly expected across financial markets.

The RBA was slightly more upbeat in its assessment of the global economy than it has been previously. While highlighting the stronger growth in prospect for China, the Bank warned that the debt funded nature and the composition of the growth suggest that risks remain in the medium term.

In other aspects, the commentary was largely consistent with similar statements over recent months.

In terms of global monetary policy, the Bank was particularly forthcoming in their comments, noting; “Interest rates are expected to increase further in the United States and there is no longer an expectation of additional monetary easing in other major economies”. Against this background, it is challenging to see the RBA leading central banks by cutting rates in Australia over the course of 2017.

What are the RBA’s main concerns?

While noting that the RBA was generally upbeat about the global and Australian outlook, several aspects were highlighted as potential concerns, including:

  • The speed, source and composition of the Chinese growth story.
  • While consumption growth in Australia was strong over the final quarter of 2016, it was largely funded by running down savings as income growth remains subdued. This is not sustainable over the medium term, especially given the high level of household indebtedness and the likely higher level of interest rates at some stage in the future.
  • A further appreciation of the exchange rate will complicate the adjustment process currently underway.

What is the RBA’s view on the Australian dollar?

While the RBA rarely comments directly on the exchange rate, it is clear they would prefer to see a lower AUD as opposed to the continuation of the recent strengthening trend. The path of the AUD is being influenced by two opposing forces; namely stronger commodity prices and the very strong likelihood of higher USD interest rates. In the end, it is likely the AUD will retreat from current levels as the current heat in the commodity markets cools and equally as US rates move higher.

What is the RBA’s view on inflation this year? Could this lead to rate rises this year?

The RBA sees inflation picking up over the course of 2017 to be above the lower boundary point of 2%. Underlying inflation is expected to rise on a slightly more gradual trajectory. On this basis, it is difficult to see inflation being a driver for higher interest rates.

What is ING Direct’s view on the economy?

We would broadly agree with the RBA’s view on the economy and the outlook for interest and exchange rates. In terms of interest rates, we expect to see them move higher towards the end of 2017. This will be on the basis of stronger growth across the economy, in part driven by a lower exchange rate thanks to higher US interest rates.

The sustainability of the recovery in consumer spending is a concern. The run down in savings means the economy is potentially exposed to the impact of higher interest rates. Income growth over recent years has been flat. Consumers have opted to run down savings rather than adjust their standard of living; this has potentially been on the basis of the wealth effect from higher housing prices.

Published: Wednesday, March 08, 2017


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