The global economy grew faster than trend over the year to mid 2010. The expansion has been uneven, with the major advanced countries recording only moderate growth overall but growth in Asia and Latin America very strong. There are indications that growth in China is moderating to a more sustainable rate as policies are now less accommodating. Similar adjustments to policies and growth rates are occurring in other countries in the Asian region. In Europe, while output in some key countries has been improving significantly, prospects for next year are more uncertain given planned fiscal contraction. US growth was stronger in the first half of 2010 but the pace of labour market improvement has been slow and the expansion may be somewhat lacklustre in the second half of 2010. Overall, the Bank expects global growth to be about trend over the coming year.

The caution evident in financial markets in the past few months has abated of late, helped by the disclosure of information about European banks. Nonetheless, the global outlook remains somewhat more uncertain than a few months ago and this is reflected in the volatility of financial prices. Commodity prices are off their peaks but those most important for Australia remain at very high levels, and the terms of trade are around their peak of two years ago.

With the high level of the terms of trade expected to add to incomes and demand, output growth in Australia over the year ahead is likely to be about trend, even though the effects of earlier expansionary policy measures will be diminishing. Consumption spending is recording a modest increase at present, with households displaying a degree of caution, but most indicators suggest business investment will increase over the coming year. Business credit has stabilised, though credit conditions for some sectors remain difficult. Credit outstanding for housing has continued to expand, but the upward pressure on dwelling prices appears to have abated.

The labour market has continued to firm gradually, and after the significant decline last year, growth in wages has picked up a little, as had been expected. Recent data for inflation were consistent with the Bank’s May forecasts, with underlying inflation declining to about 2¾ per cent, the lowest rate for about three years. The rate of CPI increase was a little above 3 per cent due to the effects of increases in tobacco taxes announced earlier in the year. Through to mid 2011, underlying inflation is likely to be in the top half of the target zone, while CPI inflation will probably be just above 3 per cent for a few quarters due to the impact of the tax changes and increases in utilities prices.

The current setting of monetary policy is resulting in interest rates to borrowers around their average levels of the past decade. With growth likely to be close to trend, inflation close to target and the global outlook remaining somewhat uncertain, the Board judged this setting of monetary policy to be appropriate.

It was a widely expected move and will give mortgage holders another welcome breather from the six rate hikes they have endured since September last year.

“It looks as though the earlier interest rate hikes are already biting,” says Domain.com.au blogger Carolyn Boyd. “Auction clearance rates are down and house price growth is cooling. Real estate agents are also reporting there are less people looking to buy.”

Each 0.25 per cent interest rate rise adds another $50 to the monthly cost of an average mortgage. Australian mortgage holders are already paying about $300 more per month in repayments than they were in September last year.

Mortgage holders on variable interest rates are currently being charged about 7.4 per cent by their lenders

There have been six official interest rate rises since last October and the RBA has said several times it believes rates are now back at more normal levels.

Fears about global growth and the deterioration in domestic and international financial markets are likely to see the Reserve Bank leave the cash rate steady at 4.5 per cent for a second consecutive month.

Of 22 economists surveyed by Bloomberg, none were willing to bet on a July rate rise.

Macquarie Bank interest rates strategist Rory Robertson says the global uncertainty makes predicting the next rates movement extremely tough.

“I think the Reserve Bank’s on hold for an extended period and no one really knows whether the next move is up or down, but it’s probably not going to be soon,” he said.

Mr Robertson says when the RBA last raised rates in May, it made it clear the first phase of its tightening cycle was over.

“It had returned interest rates to average levels and it was sitting firmly on its hands awaiting developments,” he said.

“Since May, we’ve seen quite a sizeable deterioration in the global economy. Various financial markets have fallen quite sharply, so I think the global outlook is not as upbeat as it was back in May.

“So the Reserve Bank’s firmly on hold.”

Mr Robertson says a big blowout in second quarter inflation remains the biggest threat to a rate rise.

“With the risk of serious economic contraction in Australia having passed some time ago, the Board has been adjusting the cash rate towards levels that would be consistent with interest rates to borrowers being close to the average experience over the past decade or more. The Board expects that, as a result of today’s decision, rates for most borrowers will be around average levels. This represents a significant adjustment from the very expansionary settings reached a year ago.”

The Reserve Bank Governor Glenn Stevens seems to allude to interest rates being around a level at which they should stay given the current climate, so there may be some relief for home owners on the way. Today’s rise means that home owners will be paying an extra $48 per month on the average sized mortgage.

We’ll let you know when the big banks follow the RBA’s lead, and if they decide to increase by any more than the 25 basis points.

With a decline in inflation and the appearance of unemployment having peaked at lower than expected levels quoted as being major reasons for the decision, Reserve Bank governor Glenn Stevens also stated in his announcement that interest rates were nearing the average – perhaps a sign of hesitancy to raise rates further in coming months.

We now wait to see how much the big four are going to increase by, despite having the gauntlet thrown down by NAB, and a couple of large credit unions to minimize the amount of increase that flows through to home owners by not raising rates above that of the reserve Bank decision today.

Currently NAB already have the lowest variable interest rates at 6.74% followed by Commonwealth Bank at 6.84%, then ANZ at 6.91% with Westpac grabbing a greedy 7.01%

Specifically citing the large banks raising of rates over and above the RBA decision after previous announcements, Glenn Stevens pointed out that most mortgage rates are now up around 1% higher than what they were when economic stimulus was put into place just over 1 year ago.

Some also think now that todays decision have had something to do with figures showing a slight increase in commodity prices, and also the large number of first home owners who couldn’t believe their luck with the increased First Home Owners Grant in combination with record low interest rates, who now find themselves in significant mortgage stress.

Predictions from 13 out of 14 economists surveyed by AAP had highlighted the need for rates to go up once again, in a sign that the Australian economy has rebounded from the global financial crisis that it never really suffered from as much as the rest of the world.

The third interest rate rise in a row means that a family with a mortgage of $350,000 will now be paying $159 more than what they were just over three months ago.

The Reserver Bank will not meet again until February 2010, when they will re-evaluate the economic position of the country, and look at the result of retail spending over the Christmas/New Year sales period.

What surprises me though is the lack of thought or foreknowledge in where we are at economically as a nation, and why the RBA interest rate needs to go up again.

Sure, it’s hard for those who have just bought a house, possibly through the now diminished First Home Owners Grant, to deal with the third such rate rise in a row. What has to be remembered however is that rates, even if they do go up again, are still at a much lower level than what they were at the same time only one year ago.

The fact is, the Australian economy is faring much better than most expected. Unemployment is almost 2% below forecast levels, and in fact dropped during the month of September. Consumer confidence is on a high, and coming up to Christmas, retailers are experiencing large turnovers. And when people are spending, inflation begins to creep up. And what is inflation?

Inflation is when the average price of goods and services begins to rise over time. If people are not buying a particular product or service, manufacturers and retailers are forced to drop the price to get turnover. But if people are continuing to buy that same product, the price can creep up as those suppliers try to make more and more profit. This happens with a whole range of things such as food, oil, rent… almost anything you can put a price on.

The real problem begins when the rate at which inflation is at begins to get higher than increases in salary and wages. If someone is earning $800/week and it costs them exactly $800/week for rent, food, power and so on, if the price of living increases to $810/week for that person, they begin to get into debt. This is where the Reserve Ban k will step in to try and slow the rate of inflation down.

Given that this is the case, we can expect to see the rate go up on Tuesday by another 25 basis points, or 0.25%, with the big banks immediately passing this on. In January however, the RBA will probably follow tradition by holding rates at that level for at least another month as post-christmas spending budgets tighten and people return to life as normal.

In short, interest rate increases aren’t all bad. If we think of the rate as returning to a normal level again, and that it only has to do this because the economy is so good in Australia, it doesn’t quite seem so bad.