What next for interest rates?

February 6, 2013, 8:45 am David Koch Yahoo7

Remember that the RBA has three official targets – a stable dollar, full employment and the economic prosperity of Australians.

The RBA has held rates steady at their first monthly board meeting of 2013 after the annual summer holiday hiatus.

It’s a great position for the bank to be able to take a wait and see approach, but begs the question, where exactly are we in the interest rate cycle?

To answer the query posed to me by so many borrowers and pensioners pondering the place for their hard earned savings, here is my take on current conditions and the interest rate outlook for 2013.

To provide some framework, remember that the RBA has three official targets – a stable dollar, full employment and the economic prosperity of Australians.

This translates to inflation target of 2 per cent to 3 per cent, unemployment of about 5 per cent and economic growth of 3 per cent to 3.5 per cent.

That’s the RBA’s ‘Goldilocks’ scenario - an economy that’s not too hot and not too cold. And guess what? We’re just about right on the money now, hence the steady cash rate.

But unfortunately it’s not as simple as that. Another more recent objective of the RBA is to support the rebalancing of spending to non-mining areas as our golden resources boom matures. Basically, Australia is approaching a position where its built most of the mines and infrastructure needed to support the industry for the foreseeable future.

The huge amount of money invested in the mining boom has been one of the key insulators of our economy from trouble abroad. And while that trouble is far from over, there is now some growth grinding out of the US, China appears to have bounced back from its “soft” economic slowdown and Europe is bumbling along OK.

If these three key areas maintain the status quo, then the mining boom has timed its insulating job to perfection. But the trouble is that without our biggest export continuing to lure money into the economy, growth will slow.

Of course this will also mean creeping unemployment unless other areas of the two-speed economy can pick up the slack.

If you didn’t already appreciate what a difficult job the RBA has in setting rates, maybe you do now. And this is only a broad look at the key variables they must consider.

It’s to say nothing of the fickleness of the chief tool at their disposal to achieve all this, the cash rate.

Despite a significant 1.25 per cent worth of rate cuts last year, consumer and business confidence continued to ebb, property prices tracked sideways and retail spending withered as consumers saved their pennies and paid down debt.

This is the opposite reaction to what they were trying to stimulate.

Thankfully it appears we are now getting some signs of confidence returning, even though it is probably more a result of buoyant share markets and the lack of bad news from abroad than any central bank action.

Whatever the case, if events outside Australia stay as they are, we are likely to have seen the bottom of this interest rate cycle. The current 3 per cent cash rate is considered an emergency level by the RBA, so to go below it would require some pretty sincere provocation.

The irony is that this provocation would most likely come from the thing that has allowed us to weather the GFC recession free and maintain high interest rates the envy of the world, the mining industry.

If prices for our biggest exports wane in the second half on 2013, as many industry observers are tipping, the rebalancing of spending will need to be hastened. And, as we’ve covered, the fickle tool the RBA will brandish is the cash rate.

Mind you, economic commentators have been on about the end of the mining boom for years now, so until we see hard evidence of China’s appetite for iron ore being quenched, I don’t expect rates to go any lower.

What does this mean? Clear out your debt while it’s cheap, consider fixing part of your mortgage if you have one, and be confident - it’s all RBA Governor Glenn Stevens is asking of you.

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