New Zealand has already hiked interest rates and Australia could start doing likewise in 2015, following the U.S. Federal Reserve, a leading Australian economist has warned.
Speaking Wednesday at the Queensland Japan Chamber of Commerce and Industry (QJCCI) in Brisbane, Australia, ANZ Senior Economist Justin Fabo predicted that the Fed would increase rates by mid-2015, with Australia’s Reserve Bank of Australia (RBA) to follow.
“We think the Fed will look to raise rates before the middle of next year at the latest, and our central bank will probably increase rates shortly thereafter. There’s no necessity for the RBA to wait for the Fed to move, but because of the role of the currency, we think that’s the way it will work out,” he said.
On Thursday, the Reserve Bank of New Zealand (RBNZ) raised its official cash rate for the fourth time this year, increasing it by 0.25 percentage point to 3.5 percent. In March, New Zealand became the first advanced Western economy to start increasing rates following the global financial crisis (GFC), with others seemingly set to follow.
Announcing the latest rate hike, RBNZ governor Graeme Wheeler said in a statement: “New Zealand’s economy is expected to grow at an annual pace of 3.7 percent over 2014. Global financial conditions remain very accommodative and are reflected in low interest rates, narrow risk spreads, and low financial market volatility. Economic growth among New Zealand’s trading partners has eased slightly in the first half of 2014, but this appears to be due to temporary factors.”
Wheeler pointed to strong growth in construction as well as net immigration, although he described the Kiwi currency’s elevated level as “unjustified and unsustainable…[with] potential for a significant fall.”
“Inflation remains moderate, but strong growth in output has been absorbing spare capacity,” he said, adding the latest hike would “help keep future average inflation near the 2 percent target mid-point and ensure that the economic expansion can be sustained.”
ANZ’s Fabo said the RBNZ had hiked rates as its economy was “steaming along,” but the outlook for Australia was more moderate.
“We think the outlook for interest rates [in Australia] is for very gradual increases over the next three to five years, because the growth backdrop is different – it’s not as strong as pre-GFC,” he said.
The Australian bank’s research team expects the U.S. federal funds rate to reach 0.5 percent by June 2015 and 1 percent by year-end, as part of the “normalization” of monetary policy. On Thursday, the International Monetary Fund warned of the risk of “a renewed rise in longer-term interest rates, particularly if U.S. long-term rates increase more sharply and rapidly than expected as monetary policy normalization proceeds,” although it expects U.S. growth to expand from 1.7 percent in 2014 to 3 percent next year.
Fabo said a change in commentary by the Fed could spark a swift reaction by financial markets, given current low levels of market volatility.
“We think there’s a real risk that once volatility picks up…the realignment in both currency and interest rate markets could be very abrupt in that initial period. Once that happens, our currency will start moving down and the outlook for rates will move up,” he said.
ANZ expects Australia’s benchmark RBA cash rate to rise from its current record low of 2.5 percent to 2.75 percent in March 2015, 3 percent in June and 3.5 percent by next December, as it plays catch up to its cross-Tasman counterpart.
Fabo said the Australian dollar should be “somewhere around the high 80s [against the U.S. dollar}” compared to its current level around $0.94 due to lower export prices.
“The RBA doesn’t forecast currencies…but the governor has said that the currency should be lower, and not just a few cents, and we completely agree. We think it should be at least five cents lower, 87 cents by the end of this year and 84-85 into next year,” he said.
“The reason the [Australian] currency is elevated is because the U.S. dollar is too weak. Markets aren’t seeing interest rates going up much anytime soon in the U.S., and there’s a huge amount of liquidity searching for yield…so there’s a lot of money coming into Aussie assets still.”
Commenting on the outlook, Fabo said the global economy was improving, although “we’re not out of the woods yet.”
“We’re still in the long shadow from the GFC, and when you have financial crises, these long shadows tend to last for seven to 10 years, so we’re still in that seven-year period. Hopefully it’s just seven years this time, but that’s what history has told us about financial crises,” he said.
Nevertheless, he noted the “encouraging news” from the United States as part of an improved global outlook, although Australia had now “come back to the pack” after a period of outperformance.
Fabo said the outlook for Australia’s economy was for “a gradual improvement in growth [above 3 per cent]…low interest rates are gaining some traction and supporting the non-mining economy, and we’re just starting to see some signs that business investment outside the resources sector is looking better.”
He said current low interest rates could spur a “mini-boom” in building, aiding construction jobs and consumer confidence. However, he warned that the “pipeline of major [resources] projects is bare” following the end of the mining boom, requiring a weaker currency to help spur growth in sectors such as tourism.
Concerning Australia’s major trading partners, Fabo said second-largest trading partner, Japan, was showing positive signs under “Abenomics,” but it was too early to make a conclusive call.
“[Japan] has probably had the longest shadow that any country has ever seen [from its 1990s bubble burst] and they’re still copping the fallout…We’ll only know 10 years down the track really whether [Abenomics] has worked…it’s the same with quantitative easing in the U.S.,” he said.
Nevertheless, he said the outlook for Japan had improved: “It looks like in the next couple of years, Japan’s economy will grow a couple of percent a year, and that’s hugely different to the average of the last 20 years.”
Meanwhile, Australia and New Zealand face the issue of preventing their property sectors from overheating, while attempting to weaken their currencies to aid exporters despite attractively high interest rates for overseas investors. The message to the Fed is clear: bring on that rate hike.