22 Sep THE INTEREST RATE DIVISION DECISION

Interest rate mixed signals – Is now the time to borrow?

This article assesses the latest mixed signals on interest rate policy here and abroad. It also looks at the latest evidence to assess if now is a good time to start planning for future investments to take advantage of the extended low interest rate environment.

First the short term – market at odds with RBA?

Recently released minutes of the latest Reserve Bank of Australia Monetary Policy Meeting revealed the RBA is still maintaining a slight interest rate easing bias. Several factors will continue to underpin the low interest rate environment going forward, and talk of rate hikes in 2014 is premature.

1. Lower rates are needed by the RBA to attempt to weaken the dollar to support economic rebalancing in the period ahead and stimulate other key sectors (homebuilding, services etc)
2. Inflation remains low, unemployment is rising, and non-mining growth is weak
3. Domestic risks are high as we approach the mining investment cliff
4. External risks remain heightened in the US (as highlighted by Fed), Europe, China and Japan
5. Australian fiscal policy is likely to be contractionary in the period ahead.

I think short term rates could fall to 2% but this is as far as the RBA could go in this cycle without further increasing already extreme house price risks. Either way rates are close to a bottom and I think will stay there for most of 2014 and into 2015 to support activity and a lower dollar.

Then the longer term

Analysis of longer term rates shows that the market is now pricing in future rate rises, as confidence grows at home and internationally that the period of ultra-loose policy is ending, albeit slowly.  The 10 year Australian government bond yield 2023 (purple line) rose from 3.69% in mid-August, to 4.17% on September 11, before easing to 4.00% on Sep 19 after the Fed reserve meeting.  Markets continue to be led by international events including the mixed signals around the U.S. reduction in quantitative easing. Soon though developed nations will begin to move off the economic life-support system put in place post GFC, and consider raising interest rates away from emergency levels, albeit to still low historical levels.