What next for your mortgage?

Not meaning to pick on anyone in particular

Interest rates are going up. No, wait! Interest rates are going down. Er, interest rates are staying on hold. Confused?
The global financial crisis has claimed a new victim: the interest rate forecasting industry. Predicting monthly moves by the Reserve Bank is big business. Every bank employs a team of economists to predict the future of interest rates. You know them. They are those well groomed, confident people you see on the news, slotted in before the weather forecast, who offer bold pronouncements on where markets and interest rates are heading. But lately, it seems, the weather guys have been winning.

There has been a genuine change in the level of uncertainty that confronts the economy. Two decades that economists had come to call the Great Moderation – a time of stable economic growth and low inflation – have come to an end. Now, we have the Great Volatility, where every morning brings the possibility of a new Euro contagion or fresh financial crisis. Nature also seems in on the act, calling forth floods, earthquakes and tsunamis to wreak havoc on economic production.

In his statement on Tuesday accompanying the Reserve’s decision to keep rates on hold for an eighth consecutive month, its governor, Glenn Stevens, flagged slower than anticipated growth this calendar year, due to a slower than expected recovery in coal exports after the Queensland floods.

Many open-pit mines in the Bowen Basin remain giant swimming pools, unable to discharge their dirty water into nearby creeks because of environmental restrictions. Mines have been forced to pump water around into old pits or simply wait for more rain to fill dry creek beds so the water can be safely discharged. In a very direct way, forecasting the future of coal exports can be no more accurate than the weather forecast.

The Reserve indicated this week it had no desire to lift interest rates, for now, given that shrinking retail sales, slower growth in employment and the new caution towards debt by home borrowers are doing the work for it to cool inflation pressure.

But the bigger picture for the economy remains one in which a massive external income shock – foreigners paying hand over fist for our exports – is being met with limited spare capacity in workers and equipment. Higher demand and limited supply create the potential for wages growth that could fuel inflation. It hasn’t happened yet but it might.

In a speech last week, the Reserve Bank assistant governor Philip Lowe recalled how the bank was surprised in 2007 by the speed of the rise in prices, speculating that perhaps there might be some “threshold” for skills shortages and capacity constraints “which, when crossed, causes inflation to increase very quickly”.

That is why the bank is watching like a hawk for the next official report on inflation, due at the end of this month. Most forecasters are tipping a quarterly increase in prices of 0.7 per cent, which annualises to a general increase of 2.8 per cent, still within the Reserve’s target band of 2 to 3 per cent. Anything much higher will cause consternation at the Reserve and force it to decide between observable signs of weakness in non-mining parts of the economy and its medium-term concern about a pick-up in inflation. There can be no doubting the bank’s determination to keep inflation in check.

But we’ll have to get through July first. It remains possible that the crisis in Greece and other Eurozone countries could change all this. If we woke up one morning to the news that the Greek parliament had decided to ditch the Euro for the drachma and default on its debt repayments, this could very quickly spark another seizure in the global credit supply, leading to businesses cancelling orders and shedding jobs. Commodity prices would tumble and, yes, the Reserve would be thinking about cutting interest rates.

It is also possible that the carbon tax debate becomes so vicious that Australians literally talk themselves into a retail recession. Tellingly, in the part of the Westpac-Melbourne Institute survey of consumer sentiment that asks people what news they most recall hearing, recall of tax issues is the highest since the introduction of the GST.
“The degree of negativity from respondents about taxation issues is large … despite steady interest rates and falling petrol prices, concerns about the introduction of a price on carbon are rattling households,” Westpac’s chief economist, Bill Evans, wrote in last month’s report.

So, Carbon Sunday – and the shoe-leather wearing-out campaign that will follow to sell the government’s scheme – is shaping as critical not only for the climate but also for the economy. If the government is successful in convincing households they will not be much worse off under the tax, this negativity could quickly reverse, leading to a rise in spending and inflation risks.

On the other hand, should Tony Abbott’s relentless scare campaign about price rises under a carbon tax continue to hit home, households may bunker down for months or years. It would be a brave economist who hung an economic forecast on the federal government’s ability to sell its policies successfully.

What advice, then, for nervous mortgage holders? Interest rates appear to be on hold for now. But it wouldn’t take much, just one nasty inflation reading, to put rises firmly back on the agenda. But that, of course, is only a prediction.

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This entry was posted in Climate change, Gillard Government, Housing, Inflation, Interest Rates, Reserve Bank. Bookmark the permalink.

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