Jobs up, rates rise, more to come

The Reserve Bank has increased official interest rates by 0.25 percentage points to 5 per cent, lifting repayments on the average $180,000 25-year home loan by $30 a month. In announcing the lift, the tone of the RBA's statement suggests that unless strengthening domestic and international conditions change direction markedly, there will be more rate rises sooner rather than later. The subsequent release of jobs figures showing another surprise fall in unemployment to just 5.6 per cent during October on the back of a solid 20,000 rise in full-time jobs only increases these chances.

The RBA says that an improving world economy and a stronger local economy means that the low, stimulatory levels of interest rates we've had for so long are now no longer appropriate. The Bank specifically singled out the “behaviour of borrowers” and said that excessive borrowing by households “shows no sign of abating”. This threatens to inject an unsustainable imbalance into the Australian economy, the statement says. In these circumstances, this first small quarter-percent rise in rates can be expected to be followed by more such increases – as soon as December or February.

Record household debt levels mean it may not take a rise in rates of more than 0.75 to 1 percentage point to have the desired effect in reining in borrowing levels. In a recent Infochoice online poll, 18 per cent of respondents said they could not cope with any interest rate increase over the next year while a further 22 per cent said they could only handle rises of less than 1 percentage point.

Criticism of the RBA's action to lift rates has been based largely on the inflation picture. It's true that at 2.6 per cent inflation is currently well contained within its target band and the effect of our rising Aussie dollar will inject further anti-inflationary impetus to the economy. However, the currency impact is probably being overdone (the $A isn't rising against all currencies) at the expense of other indicators that could well boost inflation over the next year.

The RBA sets interest rates according to where the economy is expected to be in six to 12 months and if the world recovery fully materialises and the local economy continues to power on, then the pro-inflation factors could well outweigh the anti next year. For a start, look out for wage pressures if the job market continues in its current vein. As such, the risks are now well and truly on the upside, the rate rise was well timed and more modest increases sooner rather later appear prudent. The RBA's quarterly monetary policy statement out on Monday will give valuable insight into these prospects.