ANZ says two rate hikes are coming next year

KARIM SAHIB / AFP / Getty Images

The Reserve Bank of Australia (RBA) looks set to increase official interest rates twice next year, bringing to an end the bank’s elongated easing cycle that began in late 2011.

That’s the view of ANZ’s Australian economics team who believe a combination of stronger-than-expected economic growth and labour market conditions, along with signs that inflationary pressures have bottomed, will see the RBA hike rates for the first time since November 2010.

“The change to our view on the RBA reflects an outlook for growth that is a touch more positive than previously and an easing to the downside risks to both growth and inflation,” said David Plank and Felicity Emmett, economists at ANZ.

“We see growth of 2.9% in 2018 and 3% in 2019, with the unemployment rate declining to 5.3% by the end of next year.”

Here’s the bank’s updated economic forecasts for real GDP growth.

Source: ANZ

“The small upward revisions largely reflect the fact that some downside risks we identified earlier have abated somewhat, and some of the upside risks we’ve flagged have played out,” Plank and Emmett say.

“Specifically, investment, both on the private and public side, looks set to be stronger.”

Along with public and private sector investment, ANZ says that the downturn in Australian residential construction will probably be shallower than earlier estimates, further bolstering the case for higher interest rates.

“There is still a substantial amount of work in the pipeline which should support the level of activity over the balance of this year,” say Plank and Emmett.

“Moreover, the recent surge in housing finance approvals for construction suggests that approvals are likely to remain well supported over the next few months.

“This should see construction activity remain elevated through 2017 and early 2018, before falling from mid-2018.”

And while ANZ isn’t expecting household consumption to lift in any meaningful manner, something that other forecasters have cited as a reason as to why the RBA should leave interest rates on hold for the foreseeable future, it says that stronger-than-expected growth, and with it a pickup in inflationary pressures, should see the RBA begin normalising policy settings in the first half of 2018.

“We think our outlook for growth and the labour market in 2018, along with the easing of the downside risks, means a negative real cash rate setting is no longer required,” Plank and Emmett say.

“As a result we are now forecasting two rate hikes by the RBA in 2018, with the first in May and another in the second half of the year.

“We think the tightening will be portrayed by the Bank as one aimed at taking back the 2016 stimulus. With the real cash rate back at zero, we think the Bank will likely indicate a willingness to sit still for an extended period as it assesses the impact of the tightening on the economy, not least the AUD.”

Real interest rates are the RBA’s official nominal cash rate minus annual consumer price inflation.

Source: ANZ

The move from ANZ follows a similar tweak to interest rate forecasts from the National Australia Bank (NAB) last week.

However, while the NAB is predicting four 25 basis point increases from the RBA before the end of 2019 — two in 2018 and two in 2019 leaving the cash rate at 2.5% — ANZ says concerns around the household sector should see the cash rate remain at 2% throughout the course of 2019.

“Even if the RBA does enter into the cycle with the expectation that it will tighten by more than 50bp, we think the reaction of households to the move will quickly persuade the Bank that this will be enough for now,” says Plank and Emmett.

ANZ says downside risks to its call may come from a sharply stronger Australian dollar, or from an undershoot in wage and inflationary pressures next year.

On the upside, it says that a strong acceleration in wage or inflationary pressures — or both — in 2019 would “lessen the burden of the
2018 hikes and possibly see the RBA push the cash rate somewhat higher”.

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.