The Reserve Bank’s latest quarterly Statement on Monetary Policy has given further insight into the central bank’s increasingly optimistic view of the Australian economy, confirming further rate rises are on the way next year.

The RBA has been careful to avoid discussing the likely speed of interest rate rises, but have said they are heading toward a more”normal” monetary policy stance of around 5-6 per cent. Once again their statement offered little in the way of timing but it suggests that the central bank is planning to reach five per cent sometime in 2011 – assuming continued improvement in global economic conditions.

Opinions remain mixed as to the chances of a third straight hike next month, however, with many now expecting the RBA to hold off until next year as they wait to assess the impact of the first two hikes.

“The large downside risks that were evident six months ago have … diminished,” the RBA advised. “Significant risks, nevertheless, remain. Activity has recently been boosted by temporary fiscal measures and a slowing in the pace of inventory run-down, with the durability of the pick-up in growth remaining uncertain. Banking systems in a number of countries are still some way from full health and further bad news in the financial sector cannot be ruled out.”

“Economic conditions in Australia have also been stronger than expected. In contrast to other developed economies, the Australian economy is estimated to have expanded, albeit modestly, over the first half of the year and recent data suggest that this expansion has continued into the second half.”

The Reserve Bank reiterated their concern about the supply side of the housing market, noting a need for more housing in the next couple of years to alleviate the pressures of a growing population.

“Housing prices have strengthened considerably over the course of the year, with prices in most areas now above their previous peaks,” they stated. “Lending approvals have risen noticeably, although the same pick-up is not evident in housing credit growth as many borrowers have taken advantage of low mortgage rates to pay down their mortgage more quickly than in the past.”

“A recovery in housing construction is now clearly under way, with leading indicators of house building well above the levels of late 2008, although financing issues are constraining activity in the apartment market. There are, however, likely to be ongoing pressures in the housing market over the next few years, with the Australian population growing at its fastest rate since the 1960s.”

“Addressing these pressures will require further steps to improve the supply side of the housing market.”

Growth expectations surge

The central bank also took the opportunity to revise upward their forecasts for economic growth – from less than one per cent to just over two per cent in the year to June 2010.

Inflation, which largely guides monetary policy, has taken longer to subside than first expected. As a result they do not anticipate it falling as much as previously thought. However, underlying inflation is expected to fall to 2.25% by the end of next year, ensuring it will be within the mid-term target range of 2-3 per cent and possibly reducing the pressure to raise rates.

Outlook

“Given this (positive) assessment, the Board has judged it prudent to lessen the degree of monetary stimulus that was put in place when the outlook appeared much weaker, increasing the cash rate by 25 basis points at both its October and November meetings,” the RBA reported. “The cash rate remains at a low level, and a further gradual lessening of monetary stimulus is likely to be required over time if the economy evolves broadly as expected.”

“The Board will continue to monitor developments closely and set monetary policy so as to promote sustainable growth in the Australian economy and keep inflation consistent with the medium-term target.”