Yong-Long Lai

Hi All,

Here’s the exciting news that you’ve all been waiting for As expected the interest rate has gone up by 0.25% to 6.75%, Also last week the US dropped their interest rate by 0.25%.For the people who haven’t locked in their rates, they can pay a cap fee and re-finance their existing loans to the fix rate before the banks actually pass the new revised rate.From my experience you only have a couple of days! so act quickly and paid the fee! Can you really afford another rate raise?

if you have a 200k loan you will need $500 after tax dollar more a year if you have a 400k loan you will need $1,000 after tax dollar more a year if you have a 600k loan you will need $1,500 after tax dollar more a year if you are an investor, pass on the rate raise to your tenants! if you can’t, the government will buffer you with a tax deduction on this increase (thank god for -ve gearing)

Depending how the economy moves and the performance of the US economy in the next few months we may expect another rate raise.Its good times in Australia (obviously), people will know this by the way the are spending, holidays they have gone to, their pay raises they got for doing not much more, their share investment sky rocketing and even their property prices doubling. All I can say is that its an awesome time to be in Australia (given that you take advantage of all the opportunities out there) Australia is truly powered by China atm and we are definitely reaping the golden times!

What does all this mean for us?

• The exchange rate for Australia against all other major currencies is moving up (i.e. if you have holiday plans, you’ll be very happy because you get more spending for doing nothing). If not, plan some overseas trip now for the short term!
• If you are in the export business you are going to suffer because your AUD goods/services is now more expensive
• If you have investment property you’ll most probably see rent going up,up and up! happy days for property investors! (hope you fixed those rates to cap your expenses)
• If you are a renter, you better budget for more rent raises! Us property investors have mortgages to pay too!
• might be a time for you to look to overseas investments as your dollar buys more!
• The share market should perform worse due to the increase in interest payments on companies loan which will eat straight into their profits (surprisingly the market is going up ~1% atm)
• don’t borrow too much money on bad debts (personal debts – personal car, house, holiday) It might cost more by the end of the year

Good luck to all of you and happy investing!

PS: if you don’t think my 50cents worth of information is valuable then check out HBOSA’s economist thoughts…

Yong-Long

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Disclaimer at the bottom!

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Cash rate up by 25 basis points

To 11-year high of 6.75% pa, and

Set to rise further, either next month, or

More likely in February next year, unless

Sub-prime contagion gets really nasty, which the RBA does not expect

$A soaring against all-comers except the kiwi

Which is even more in demand as yen carry trade comes back into fashion, but

Even the yen is rising against a $US that is in virtual free-fall

ABS house price indices rise in all cities in September quarter, but

New housing finance approvals fall in September quarter as August cash rate increase starts to bite

Approvals for finance to construct new dwelling continue to grow, but

At a much slower rate, so

Little or no sign of a meaningful recovery in the dwelling construction cycle

The RBA delivered its much anticipated 25 basis point cash rate increase, to an 11-year high of 6.75% pa, and pretty much signalled that unless sub-prime contagion spreads beyond the financial sector itself, at least one more is in the offing sooner rather than later.

As soon as next month? Next week s labour price index would have to be on the high side for that to happen, you would think, but if the housing market looks as though it is returning from its traditional Christmas/new year holiday by the time the RBA Board meets for the first time next year (on the 5th of February), the late January publication of the December quarter CPI will likely have given the central bank all the ammunition it needs to push the cash rate up to 7.0% pa for the first time since October 1996 – but it was on the way down back then.

And the RBA thinks that By the March quarter of next year, both headline and underlying measures of inflation are likely to be above 3 per cent .

So what could stop the central bank raising the cash rate again? A nasty dose of sub-prime contagion would do it, but while the RBA notes that global financial dislocation has triggered downward revisions to the economic growth outlook for the countries most directly affected by volatile debt markets, it is telling that, at least for now, the RBA judges that The world economy is still expected to grow at an above-average pace, however, led by strong growth in China and other parts of Asia. High global commodity prices remain an important source of stimulus to Australian spending and activity .

On the subject of commodity prices, the $US gold price has at least set one all-time record – it has not yet managed to hit the $850 it touched, literally for one day, in January 1980, but it has now tracked above $800 for three days in a row. Back in 1980, it only managed two days, and was back below $700 two days later. That s probably not going to happen this time unless the oil price, which it is chasing higher, retreats markedly from its own all-time high of $96.70 reached in New York last night.

Base metal prices were always the most exposed to sub-prime contagion, but while they are down around 15 per cent in multi-currency terms since their historical high in May (20 per cent when denominated in an Australian dollar that is around 10 US cents higher than it was in May), they are still well above what they were at the start of 2005. If speculative positions had been unwound big-time by hedge funds to offset sub-prime losses, base-metal prices would be much lower than they are. That s not to say that there is no chance of starting work one day in Australia and staring at a precipitous overnight fall in base metal prices on the London Metal Exchange (LME), but rather that unless it actually happens by early February, high commodity prices are likely to fuel, rather than dampen, upside inflation risks.

Base metals account for only 16 per cent of the benchmark RBA index of commodity prices, although they are the coal mine canaries of signs of imminent danger in commodity prices generally. Coal and iron ore account for around one third of the RBA index, and if the RBA is right on China, prices of the big two are unlikely to fall dramatically in 2008, let alone by February. But if they do, upside inflation risk would be the least of the RBA s worry.

The RBA acknowledges that The rise in the exchange rate will help to contain pressure on prices . But in the very next sentence bluntly states that growth in aggregate demand will, nonetheless, need to moderate if inflation is to be kept to 2-3 per cent in the medium term .

Ok, so where is the slowing in growth going to come from? Approvals for new housing finance fell in September, and by 3.1 per cent in the September quarter, after growing strongly in the two previous quarters. The construction component of the $66 billion of new approvals in the first quarter of the 2007-08 financial year grew modestly, to $5 billion, but at a much slower rate (1.5 per cent) than the previous quarter s clip of 4.4 per cent. So it seems that the August cash rate increase is having some affect after all. At the very least, housing finance approvals do not point to anything much, if at all, in the way of an acceleration in the dwelling construction cycle. So the RBA s worry there is not that the dwelling cycle is about to take off, but rather that the absence of an impending increase in the supply of dwellings in an already tight rental market will do nothing to arrest rising rents, which in itself is inflationary.

Again, if the RBA is right about China, business investment is likely to remain robust, and in any case they don t want it to slow markedly – although if it does it would take some of the heat out of non-residential construction inflation. That leaves household consumption, which accounts for 60 per cent of GDP. No new data out today on that one, although it was only last week that September quarter inflation adjusted retail turnover revealed a strong rebound in all states except Tasmania, where it was already strong anyway. The retail data undoubtedly would have strengthened further what was already a solid case for today s cash rate increase.

The risk of at least one more cash rate increase in coming months is clearly significant, probably in the order of 60-70 per cent. And another one on top of that? That clearly is a risk, for sure, but the August cash rate increase, let alone today s, is still working its way through the system, while the RBA does note that confidence remains fragile in respect to global financial market developments. So to extrapolate a cyclical cash rate above 7.0% pa when monetary policy is already well and truly restrictive (ie cash is now around 75-100 basis points above neutral) would be getting way too far ahead of the long and variable lags in the operation of monetary policy, given that some of the residual effects of the three cash rate increase in 2006 also are still percolating through the economy.

Alan Langford
Chief Economist
HBOS Australia
Level 8
BankWest Tower
108 St. Georges Tce, Perth
Western Australia 6000
phone: +61 08 9449 6354
fax: +61 08 9449 6266
e-mail: alan.langford@hbosa.com.au

The information contained in this publication is of a general nature and is not intended to be nor should it be considered as professional advice. You should not act on the basis of anything contained in this publication without first obtaining specific professional advice. To the extent permitted by law, HBOS Australia Pty Ltd, its related bodies corporate, employees and contractors accepts no liability or responsibility to any persons for any loss which may be incurred or suffered as a result of acting on or refraining from acting as a result of anything contained in this publication.

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