Interest rates expected to remain the same into 2014.

Standard Life Investments, the global asset manager, believes the Reserve Bank of Australia is likely to keep interest rates on hold well into 2014, with the strength of the housing market giving the central bank little room to lower rates despite its desire for a lower exchange rate.

Speaking yesterday in Sydney, Jeremy Lawson, Chief Economist, Standard Life Investments, said: “The Reserve Bank of Australia’s (RBA) decision to leave interest rates unchanged in December highlights the policy tightrope the authorities are walking. On one hand, the central bank needs ultra-low interest rates to drive the Australian dollar lower and help rebalance economic activity away from mining activity. On the other, cutting rates too far could fuel an unsustainable housing boom that eventually undermines both financial and price stability.

“In our view, the RBA is now likely to keep interest rates on hold well into 2014, with the relative magnitudes of the mining investment cliff and any housing induced surge in domestic demand determining whether the next rate move is up or down. The RBA has been keen to point out that it is not worried about the latest annualised price increases in the housing market.

“However, I believe that if house prices nationwide were to jump by another, say 10 per cent, over the next year, and underlying inflation remains around the middle of the RBA’s target band, the central bank could face some uncomfortable choices.

“Historically, strong home price growth in Australia has been associated with stronger domestic activity, suggesting that there may be some upside risks to the RBA’s economic forecasts for 2014. Moreover, as the US Federal Reserve, as well as the Spanish and Irish governments can attest, identifying when house prices are overvalued is difficult at the best of times.

“In those circumstances, will the RBA begin pre-emptively increasing interest rates to cool off the housing market at the cost of seeing the exchange rate move higher? Or will they stay their hand and risk a destabilising housing bubble developing?

“Fortunately, I believe that a third option does exist. In conjunction with the Australian Prudential Regulatory Authority, the central bank could choose to deploy macro-prudential tools such as lowering maximum loan-to-valuation ratios on mortgages or counter cyclical capital buffers. That would allow the RBA to tighten lending conditions in the housing sector without raising its policy rate, better targeting the problem at its source and thereby avoiding a sharp exchange rate appreciation.

“In the past, the RBA has chosen not to go down this route, preferring to jawbone the housing market and target housing with its traditional policy instruments; 2014 may well test that preference.”

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