Tim Toohey says brace for interest rate hikes this year - Ellerston Global Macro Fund
February 2018 | BY Tim Toohey
Get set for Australian interest rates to start moving higher in the second half of this year.
That’s the message from Tim Toohey, the global economist at Ellerston Capital, who is predicting that the Reserve Bank of Australia (RBA) will start lifting the cash rate in the second half of this year, as part of a three-year tightening process that will see the cash rate rise by 125 basis points (1.25 percentage point) from its present level of 1.5 per cent.
What’s more, Toohey says, Australian households need not be cowed by the prospect of higher rates.
“On our forecasts, the net impact of raising interest rates by 125 basis points on household income over a three-year period would be entirely manageable. Indeed, the Australian household sector in aggregate is unlikely to shed too many financial tears as the RBA steadily recalibrates policy settings towards neutral.”
Toohey’s predictions have always been closely watched. But investors are paying even more attention after Toohey correctly predicted last year that bond yields in developed countries would rise as US inflationary pressures intensified, at a time when the world’s major central banks were responding to stronger growth by easing back on monetary stimulus.
The US sharemarket suffered a vicious sell-off on Friday, after fears of rising US inflation pushed the yield on 10-year US bond yields to 2.85 per cent, the highest level in four years.
In his latest article, Toohey attacks the widely held view that the Reserve Bank will be hamstrung in its ability to raise rates because debt levels are at record levels, consumers are tapped out, and the Australian economy faces the twin perils of a China bust and a housing collapse.
Instead, Toohey says “we believe the case for normalising interest rates in Australia is continuing to build and the vulnerabilities within the economy are too often overstated.”
Toohey notes that although debt levels have risen, “the reality is that households have never been wealthier, both in gross and in net terms”, with the net worth of Australian households (which measures the value of their assets less debt) is now well above the 2007 peak.
This rising wealth has also helped push household leverage levels “back into the relatively stable range that households enjoyed over the 1997-2007 decade”.
Consumer spending to accelerate
Toohey argues that rising household wealth should help encourage an ongoing recovery in consumer spending, despite meagre household income growth.
“If consumer confidence holds at the levels suggested by the ANZ Survey … then retail sales can be expected to accelerate towards 7 per cent year on year, from its current lacklustre pace of 2.9 per cent year on year.”
Toohey also takes aim at arguments that consumers have been tightening their purse strings in response to sharp rises in utility, health and petrol prices, or because of a spike in their mortgage payments, as banks have put pressure on people with interest-only homes loans to switch into principal and interest loans.
Instead, he says, the sharp slowdown in retail spending in the third quarter of last year reflected a rush by people to stash money in their superannuation schemes before the federal government closed the window on large voluntary contributions into superannuation schemes.
“This was an opportunistic allocation of funds and diversion of income to take advantage of the taxation advantages from Australia’s superannuation system before legislation to limit the voluntary inflows came into effect”, Toohey says.
The amount of money channelled away from spending into superannuation, he estimates, “was over 18 times the size of the combined impact of the increased expenditure required for essential spending items and the impact of the shift from interest-only loans.
“As such, there is little surprise that discretionary retail sales spending was so volatile during the second half of 2017.”
But the big question is whether the time is ripe for the RBA to start tightening. Most indicators – such as buoyant business conditions, robust business and consumer confidence, strong economic and employment growth and a falling unemployment rate – suggest that it is.
The only reservation is inflation. The headline inflation rate is currently 1.95 per cent year on year, which is below the RBA’s target of an inflation rate of 2 to 3 per cent.
As Toohey points out, “if there is one indicator that has been a necessary condition to commence a tightening cycle it is when headline inflation reaches 2.0 per cent year on year.”
In addition, he says, the RBA would also like to see signs that wages are picking up, and that underlying inflation pressures are becoming more broad-based.
“That will be the task for first half of 2018”, Toohey writes. “However, with global economic growth likely to exceed 4 per cent and a broad sweep of local indicators already suggesting that the time to adjust policy has arrived, the time for recalibration is fast approaching.”