Emerging Markets

Gradual interest rate hikes seen for Australia, Korea

The Reserve Bank of Australia is to raise interest rates more slowly than some think out of fear of putting the recovery at risk, says HSBC economist Frederic Neumann. He expects similar caution from the Bank of Korea.

  • 18 Nov 2009
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The Reserve Bank of Australia (RBA) may hike interest rates more gradually than observers anticipate, sparking similar caution from its Korean counterpart, says senior HSBC economist Frederic Neumman.

In October, the RBA became the first central bank among Group of 20 leading nations to hike interest rates, raising its cash rate 25 basis points (bp) to 3.25%. It increased rates a further 25bp this month, too.

The RBA had brought the cash rate down to a 49-year low of 3% to combat the financial crisis, but Neumann believes that the central bank will now remove the 50bp of “over-easing” to bring policy rates back up to 4% by next February.

Thereafter, he suggests, the bank will act cautiously and will bring the interest rate to no more than 4.5% by the end of 2010.

Based in Hong Kong, Neumann told asiamoney.com that it was fear of threatening the still-fragile recovery that would force the RBA’s hand.

The Australian economy is stronger than most of its peers and grew by 0.6% in the second quarter of this year, although unemployment rose to 5.8% in October, from 5.7%. Plus, the central bank is of the opinion that inflation is not an immediate problem, notes Neumann.

But the RBA will want to be careful because of the high value of household debt that is financed at variable interest rates. According to HSBC estimates, as of the third quarter, the ratio of household debt to disposal income was around 155%

“Should they [RBA] raise interest rates, it will raise the debt servicing cost for households,” said Neumann. “And in this sort of environment it is going to be a strain on household spending growth going forward.”

South Korea faces a similar problem of having a high level of household debt which is financed at low interest rates, and that is also likely to prompt the Bank of Korea (BOK) to be cautious about rate hikes.

Both countries stand out as being sensitive to interest rate changes. They both benefitted from low interest rates that spurred consumption, yet are fearful that aggressive action could derail the growth.

“We don’t expect the BOK to be terribly aggressive,” noted Neumann. “They will hike rates, but will presciently be more cautious when they do so because every time they tweak rates higher it adds debt servicing costs and dampens consumption growth.”

  • 18 Nov 2009