Why mortgages are set to rise – despite the floods

Booming trade and a tight labour market mean higher interest rates.

MORTGAGE holders should expect up to another three interest rate rises this year, despite the big blow to the economy expected from the devastating floods in Queensland, northern NSW and Victoria, economists say.

While economic activity will take a hit from the freak weather, in broader terms it is expected the floods will simply result in a shifting of such activity to later in the year.

After the Brisbane floods in 1974, there was a sharp bounce in activity three to six months later as rebuilding efforts kicked in. This time the bounce is likely to be quicker.
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Deutsche Bank senior economist Phil O’Donaghoe says the floods around Australia will cut 0.5 percentage points from economic growth in the three months to March but will result in a 0.5 percentage-point boost to the economy from the rebuilding in the June quarter.

Some predict it could be up to 1 percentage point both ways. The point is, though, that what we lose in economic activity initially, we get back later.

But there is a new problem because of the floods: many of those who will be involved in rebuilding are the same people expected to be in demand to service a boom in resources infrastructure investment this year to meet the China-driven growth in global demand.

With unemployment already a tight 5 per cent, this is a recipe for wage inflation.

St George Bank chief economist Besa Deda says the Reserve Bank will have ”its finger not that far from the trigger” all year.

”The impact of the floods will change its thinking over the next couple of months, but we expect economic growth to resume strongly after the rebuilding commences,” she says.

”There are inflationary pressures in the economy and we’ve got little spare capacity. We expect the RBA will look to lift rates by May-June, with the risk that it is earlier than that.”

Ms Deda expects two rate rises this year, taking the cash rate to 5.25 per cent by year’s end. Deutsche’s Mr O’Donaghoe is looking for three rises, adding at least another 0.75 percentage points to mortgage rates. ”We think interest rates will be left unchanged through February and March as we work through the impact, but we expect the RBA to act in Q2 [the three months to June].”

Mr O’Donaghoe says the main reason interest rates have to rise is that Australia’s terms of trade are the highest in more than 100 years due to soaring world commodity prices.

The terms of trade is a measure of the price other countries pay for Australian exports against the price we pay them for our imports – it is a measure of our national profit margin, so right now we are experiencing a historically huge growth in wealth.

The floods will add to our terms of trade because Queensland is the world’s largest supplier of seaborne coal, providing 37 per cent of the world’s market.

Global spot coking coal prices are up 25 per cent since December because of it. ”Demand for coal around the globe is strong, so partly as a consequence of the flood, we expect coal prices are heading higher,” Mr O’Donaghoe says.

Macquarie Bank senior economist Brian Redican expects the flooding will exacerbate the pressures of a two-speed economy. ”That’s because the same workers needed to rebuild the roads and rails are the same workers who work on the mines.”

Before the floods, he expected we would get an interest rate rise in February or March. Now he expects it will be in May. But he thinks this one rise will be all that’s needed.

”It’s a different story in many other parts of the economy. Consumer spending is relatively subdued and the $A is still high and having a significant impact on tourism,” he says.

Posted by Richard Webb – The Age Busines on 23rd January, 2011