This week the Reserve Bank of Australia (RBA) became the first major central bank to begin raising interest rates. Prompted by the signs of a global recovery, added to a solid local economy and continuing Federal Government stimulus, the RBA decided to raise the official cash rate by 0.25 of a percentage point.
According to the RBA governor the evidence for a rate rise was pretty clear. Forecasts for growth in 2010 have been upgraded. Confidence has recovered with business confidence at six-year highs and consumer confidence at two-year highs. Unemployment has not risen as high as expected and actually declined slightly to 5.7% this week. Inflation remains stubbornly high with underlying inflation still above the RBAs target range. Economic growth while still low appears to be holding up. And the local stock market just recorded its best quarterly rise since 1987.
The RBAs action signals its intention to start unwinding the expansionary monetary policy setting to a more neutral monetary stance. Explaining the move, the RBA governor Glenn Stevens said “[The] basis for such low interest rates has now passed”.
After the RBAs announcement the Aussie dollar rallied sharply and it is now pushing through 90 US cents. The Australian Stock Exchange (ASX) also finished slightly higher, however it was well off the highs for the day.
So what impact will the rate rise have on the Aussie stock market in the coming months?
Interest rate rises tend to be seen as a negative for stocks because borrowing costs rise. However, this interest rate rise was coming off a 49year low for rates and Tuesday’s rate rise was seen by the stock market as a vote of confidence in the economy.
The stock market has rallied around 50% from the March lows. From a technical perspective it is close to the key resistance level around 4800. After the strong run up since March, weekly volume has started to noticeably decline back towards the medium-term average. This could indicate that the stock market will experience some resistance around the 4800-5000 mark over the coming months.
From the fundamental perspective, confidence is high but business and dwelling investment remains stubbornly weak. The move towards higher interest rates may see investment continue to remain weak. Household debt has declined somewhat, yet rising interest rates may see a pull back in retail spending as households adjust their budgets.
Unemployment appears to have reached its peak, although full-time jobs have declined significantly. If economic growth remains sluggish, the prospect of higher rates could see firms defer any immediate hiring plans.
In short-term the Australian stock market appears to have both technical and fundamental challenges as it approaches the 4800 mark. Current market conditions could also be affected by the October reporting season just getting underway in the US.
A move back to a more neutral stance will help ease any inflationary pressure which will be positive for stocks. However, as the prospect of higher interest rates starts to filter through the economy, it is possible that the market will range sideways or even pullback slightly from present levels as investment and consumer spending slow. Once the short-term weakness is overcome, the medium term outlook for the stock market remains positive. This will see the next leg of the uptrend commence.
