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Escalating debt problems in Europe will force the central bank to leave rates unchanged for the immediate future, writes Shane Oliver.
The Reserve Bank of Australia (RBA) has all but confirmed that it will leave interest rates on hold until at least August.
In the minutes of its June board meeting, the RBA said rates were likely to remain stable until the impact of both the European public debt crisis and the recent spate of domestic interest rate hikes could be properly assessed.
Early indications suggest the sovereign debt crisis in Europe will last for some time to come.
Consumer confidence dipped slightly in Germany despite the strong rise in construction activity. Underlying inflation in Germany increased just 0.8 per cent over the year to April and some European countries are actually seeing deflation – indicating that there is still plenty of scope to leave interest rates low or even cut them.
But while rate cuts are likely in Europe – and the RBA looks determined to keep rates on hold in Australia until at least August – the strong May labour market report reminds us that more interest rate hikes lie in store for our nation within the next six months.
For the time being, Australian economic data remains relatively soft – with past rate hikes, share market turmoil and the debate over the proposed resources tax resulting in sharp falls in both consumer and business confidence.
Housing finance was mixed in April – down in terms of the number of new loans for owner occupiers but with investor finance continuing to recover.
Labour market data remained solid though, with a stronger than expected gain in employment in May – particularly in full time jobs – and the ANZ job ads series continuing to rise, pointing to more employment gains ahead. The continuing improvement in the labour market will help underpin household income; along with income tax cuts this should help boost consumer spending going forward.
The Australian dollar is also likely to regain its strength over the next few months as Australian interest rates remain well above global rates and as commodity prices resume their upswing.
Indeed Chinese exports are continuing to strengthen.
While inflation picked up to 3.1 per cent, it is still well below what was feared earlier this year, and in any case business surveys point to a sharp weakening in input cost pressures.
The bottom line is that measures to cool the Chinese economy and property market are working and that further tightening is unlikely. As such, we remain confident in our view of a soft landing for the Chinese economy, which will see growth fall back to around 9 to 10 per cent.
While much is made of the fact that 20 per cent of Chinese exports go the European Union, it is worth noting that only 3.5 per cent go to the key at risk countries of Portugal, Italy, Ireland, Greece and Spain.
Shane Oliver is AMP’s chief economist
Rates refer to a fixed price or an amount charged by sellers or providers for their goods and services.