Economists, IMF say rates likely to rise, as Morgan Stanley raises question of 2012 recession

The Reserve Bank may have met expectations by keeping rates steady for the ninth straight month, but hopes for a rate cut seem to have been dashed as economists now tip the central bank to hike in November.

The decision comes as the International Monetary Fund declares both the Australian dollar and Australian house prices as overvalued, and one large investment house says there is a 30% chance of a recession next year, depending on employment growth and how the nation deals with its two-speed economy.

Announcing its decision yesterday to halt rates at 4.75%, the central bank said it judged that it was “prudent to maintain the current setting of monetary policy, particularly in view of the acute sense of uncertainty in global financial markets over recent weeks.”

HSBC economist Paul Bloxham said the “policy choice of ‘least regret’ in this environment is to sit on your hands.”

Bloxham, a former RBA staffer, said hiking this week would have been “very bold, perhaps foolhardy, given the US debt situation and recent weaker in domestic sentiment.”

Nonetheless, Bloxham believes the next move is up, probably between October and December, although a September hike is possible.

“As the global risks subside, or at least move to the background, over the coming months, and some of the domestic indicators improve – which is our central case – we expect the RBA to then feel they can respond to the underlying pickup in inflation,” he writes in a note.

“In our view, this is what the RBA was communicating. The statement suggests the RBA has a distinct and definite tightening bias.”

Stevens says while the RBA expects CPI inflation to fall as the effects of the January’s floods and Cyclone Yasi subside, the “board remains concerned about the medium-term outlook for inflation.”

Going into the meeting, a survey revealed just four of 25 economists expected a hike, with most expecting a halt and none tipping a cut. Westpac chief economist Bill Evans made headlines last month by tipping a fall, rather than a hike, was on the agenda this year given weak consumer sentiment.

Some economists, such as ICAP senior economist Adam Carr, had argued that the central bank ought to focus on recent larger-than-expected inflation readings.

Recent figures showed headline inflation peaked at 3.6% last quarter, driven by soaring produce prices, and a 0.9% increase in inflation for the June quarter, with underlying inflation coming in at 2.75%. This is a 0.5% increase from six months ago.

But Stevens said yesterday declining credit growth, softening asset prices, and the high Australian dollar together point to “financial conditions being tighter than normal”.

The RBA decision comes as the International Monetary Fund sliced its Australian growth forecast for 2011 to 2%, taking into account the natural disasters, but tipped the local economy would grow by 3.5% next year, putting pressure on interest rates.

IMF division chief for Australia and New Zealand Ray Brooks said he agreed with the RBA’s decision to keep rates on hold, adding that if the European and US debt crises unfold better than most expect, there was “likely to be a need for further increases in the policy rate.”

Brooks also said Australia’s house prices were between 10 and 15% overvalued and would likely stay flat for the next few years, and the Australian dollar was up to 20% overvalued.

Meanwhile, a Morgan Stanley report has said that “financial conditions are tight enough for us to think there is a 30% risk of domestic recession in 2012.”

“We would need to see two or three months’ trend of employment decline before we would make a recession our investment base case,” Bloomberg quotes the investment bank saying.