Advertisement
Advertisement
Advertisement
Why are interest rates on the rise?
Our problem is the Australian economy hasn’t had a recession in 15 years. Because we’ve been expanding for 15 years, unemployment has been continually falling over that period. And excess capacity - the amount of buildings and equipment out there for the workforce to expand into - we’ve been using that up too.
So right now we’re pretty much at the limits as to how fast the Australian economy can grow. Unemployment is below 5 percent, and that’s the lowest unemployment has been any time in the last 30 years in terms of capacity utilisation. The highest level we’ve had any time in the last 20 years is 85 percent, and now we’re 83 percent.
So really, the economy can’t continue to grow, it can’t continue to accelerate. Really what has to happen is the Reserve Bank has to slow the economy slightly. And the only way it can slow the economy is by pushing up interest rates. Now we’ve seen interest rates go up half a percent this year to 6 percent.
Our view, however, is that in spite of that happening, what we see is that the economy continues to accelerate. We are getting strong investment from overseas in building new mines, new railways, new ports and new infrastructure.
The result is that the economy needs to be slowed further. So our conclusion is that, even though rates have already gone up half a percent, they will need to go up another half a percent between now and the middle of next year.
When rates get to 6.5 percent in the middle of next year, that’s still lower than they were in the previous similar cycle in the middle of the 1990s. Rates then got to a peak of 8.5 percent. So even though rates will go up over the year ahead, they will be still lower than they were 10 years ago.
How will the rate rise affect the stockmarket?
In terms of the stockmarket, the effect of interest rates on the stockmarket doesn’t work through short term interest rates. It’s these short term rates that the Reserve Bank influences when it puts up the cash rate, or the 90 day bank bill rate for example, and that can put up housing loan interest rates.
The interest rates that really matter for the stockmarket are not those interest rates, but long term interest rates, 10 year bond yields. Now we do believe that 10 year bond yields will also go up around about half a percent over the year ahead - not so much because of what’s happening domestically in Australia, but because we think that’s the general trend that’s happening in Europe and Asian economies and therefore will happen to us.
At the same time as long term interest rates are going up, earnings per share growth of corporations in the Australian stockmarket is slowing. So if you put up bond yields, that increases the discount rate of companies in the stockmarket. The fact that earnings growth is slowing also slows the upward momentum of the stockmarket, so what you’ve really got is a scenario for a relatively flat stockmarket.
When can we expect rates to decrease?
The underlying cycle of rate rises is really governed by not what we do, but what the central bank of the largest economy in the world, that is to say the Federal Reserve Bank of the United States does.
Over the last two years we’ve seen an aggressive tightening. They’ve put up rates by four and a quarter percent in two years. That’s the biggest tightening that the Federal Reserve has done any time in the last 20 years. And the result of that tightening is to have the effect of moving up interest rates around the world over the year ahead.
But when we get to the second half of 2007, we think the Federal Reserve will start to cut interest rates, and we think that downward movement in interest rates will spread into other economies in 2008.
So probably around about 2008 we’ll find that our own short term interest rates are starting to decline. Of course, when the fed starts cutting rates that will generate upward pressure on stockmarkets. So by the time that we get to 2008 we’ll have falling interest rates and a much better stockmarket, a rising stockmarket.
But 2008 is still a long time away.
Our problem is the Australian economy hasn’t had a recession in 15 years. Because we’ve been expanding for 15 years, unemployment has been continually falling over that period. And excess capacity - the amount of buildings and equipment out there for the workforce to expand into - we’ve been using that up too.
So right now we’re pretty much at the limits as to how fast the Australian economy can grow. Unemployment is below 5 percent, and that’s the lowest unemployment has been any time in the last 30 years in terms of capacity utilisation. The highest level we’ve had any time in the last 20 years is 85 percent, and now we’re 83 percent.
So really, the economy can’t continue to grow, it can’t continue to accelerate. Really what has to happen is the Reserve Bank has to slow the economy slightly. And the only way it can slow the economy is by pushing up interest rates. Now we’ve seen interest rates go up half a percent this year to 6 percent.
Our view, however, is that in spite of that happening, what we see is that the economy continues to accelerate. We are getting strong investment from overseas in building new mines, new railways, new ports and new infrastructure.
The result is that the economy needs to be slowed further. So our conclusion is that, even though rates have already gone up half a percent, they will need to go up another half a percent between now and the middle of next year.
When rates get to 6.5 percent in the middle of next year, that’s still lower than they were in the previous similar cycle in the middle of the 1990s. Rates then got to a peak of 8.5 percent. So even though rates will go up over the year ahead, they will be still lower than they were 10 years ago.
How will the rate rise affect the stockmarket?
In terms of the stockmarket, the effect of interest rates on the stockmarket doesn’t work through short term interest rates. It’s these short term rates that the Reserve Bank influences when it puts up the cash rate, or the 90 day bank bill rate for example, and that can put up housing loan interest rates.
The interest rates that really matter for the stockmarket are not those interest rates, but long term interest rates, 10 year bond yields. Now we do believe that 10 year bond yields will also go up around about half a percent over the year ahead - not so much because of what’s happening domestically in Australia, but because we think that’s the general trend that’s happening in Europe and Asian economies and therefore will happen to us.
At the same time as long term interest rates are going up, earnings per share growth of corporations in the Australian stockmarket is slowing. So if you put up bond yields, that increases the discount rate of companies in the stockmarket. The fact that earnings growth is slowing also slows the upward momentum of the stockmarket, so what you’ve really got is a scenario for a relatively flat stockmarket.
When can we expect rates to decrease?
The underlying cycle of rate rises is really governed by not what we do, but what the central bank of the largest economy in the world, that is to say the Federal Reserve Bank of the United States does.
Over the last two years we’ve seen an aggressive tightening. They’ve put up rates by four and a quarter percent in two years. That’s the biggest tightening that the Federal Reserve has done any time in the last 20 years. And the result of that tightening is to have the effect of moving up interest rates around the world over the year ahead.
But when we get to the second half of 2007, we think the Federal Reserve will start to cut interest rates, and we think that downward movement in interest rates will spread into other economies in 2008.
So probably around about 2008 we’ll find that our own short term interest rates are starting to decline. Of course, when the fed starts cutting rates that will generate upward pressure on stockmarkets. So by the time that we get to 2008 we’ll have falling interest rates and a much better stockmarket, a rising stockmarket.
But 2008 is still a long time away.
