Rates to rise amid global asset bubble


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Transcript of Finance News Network Interview with Professor Warwick McKibbin - Chair in Public Policy at the Crawford School at Australian National University (ANU) and Former Reserve Bank of Australia (RBA) Board Member.
Lelde Smits: Hello I’m Lelde Smits for the Finance News Network and joining me is Professor Warwick McKibbin – Chair in Public Policy at the Crawford School at Australian National University & Former Reserve Bank of Australia Board Member. Warwick, a pleasure to have you back to FNN.
Warwick McKibbin: My pleasure.
Lelde Smits: The Australian share market has started the year with a bang – surging to 21 month highs – what do you believe is behind the gains and are they sustainable?
Warwick McKibbin: Essentially foreigners have decided that Australia is a very good risk play and so they’re buying assets across the board. The easiest assets to buy are shares and therefore as the capital flows in a fair bit of it is flowing into the share market.
It is unclear whether or not the rates of dividend that will go with those investments will be sustained. But clearly, Australian assets are becoming more valuable in a world where there is a lot of risk around.
Lelde Smits: As earnings season kicks off what are you expectations for Australian companies?
Warwick McKibbin: It depends on which sectors the companies are operating in. If you are in the sectors, certain types of manufacturing are seriously weak and so I expect the earnings of those companies to be weak.
The miners are still doing well but there has been a few write-downs before the reporting season. So, it’s going to be very disparate across the spectrum. My guess however, is that it will probably be more disappointing. Certainly more disappointing than the market valuations would suggest.
Lelde Smits: And over the next 12 months what earnings or dividend growth are you expecting from Australian companies?
Warwick McKibbin: It depends very much again on which sectors the companies are in. It depends very much on what happens in the global economy. There is very large risks out there. I think the world is at the moment on a bit of a high and that to me is not sustainable when you look at what needs to be done in Europe and what needs to be done in the US.
Lelde Smits: Are you more concerned about Europe or the US?
Warwick McKibbin: Much more concerned about Europe. The US’s problem is one of excessive monetary relaxation and excessive fiscal policy. But, the US debt is all is US dollars and the US can eventually solve their problem with high inflation. The US is fundamentally a robust single currency area. Whereas the European system is being held together by will not by fundamentals.
Lelde Smits: Closer to home, the Reserve Bank of Australia has just kept the key cash rate on hold at 3 per cent – Was it an appropriate decision?
Warwick McKibbin: Yes, I think that was the right decision. I was somewhat against the previous rate decreases. I thought that an economy that is growing in nominal terms at about 5 per cent probably should have a short term interest rate of around 3-4 per cent. Adjusting for risk, even that is about an appropriate level. A rate below 3 per cent to me just leads to a misallocation of capital in the domestic economy.
Lelde Smits: Where do you see the key cash rate moving this year?
Warwick McKibbin: Well it could move anywhere. If there is a crisis in Europe it could well go down. My guess is though that it will probably be more likely to be higher than it is today. And, the main reason is that these asset price movements around the world are beginning to become very concerning. Not just in Australia, but you’re seeing asset prices, particularly houses in Hong Kong and in Thailand, really pushing the central banks to tighten their policies.
This is a global asset bubble being driven by very low interest rates in Europe, Japan and the US. And, Australia is not immune from that. And so, I think the Reserve Bank will really decide they have to respond, for example, to the recent increase in house prices in the last quarter of last year [Q4, 2012] which were quite surprisingly high.
Lelde Smits: Warwick McKibbin, thank you so much for your insights.
Warwick McKibbin: My pleasure.