Recently, forecasts for world GDP growth have been revised up again, and growth is expected to be at trend pace or a little above in 2010. Conditions in Europe remain quite weak, though recent data suggest growth is becoming more established in North America. In Asia, where financial sectors are not impaired, growth has continued to be strong, contributing to pressure on prices for raw materials. The authorities in several countries outside the major industrial economies have now started to reduce the degree of stimulus to their economies.

Global financial markets are functioning much better than they were a year ago, but sovereign risk concerns have escalated significantly in Europe over recent weeks. This has prompted additional efforts by policymakers to put fiscal policies onto a sounder footing and to provide support for Greece in the near term. To date, there has been very little contagion outside Europe.

Australia’s terms of trade are rising by more than earlier expected, and this year will probably regain the peak seen in 2008. This will add to incomes and foster a build-up in investment in the resources sector. Under these conditions, output growth over the year ahead is likely to exceed that seen last year, even though the effects of earlier expansionary policy measures will be diminishing. The process of business sector deleveraging is moderating, with business credit stabilising and indications that lenders are starting to become more willing to lend to some borrowers, though credit conditions for some sectors remain difficult. Credit outstanding for housing has been expanding at a solid pace. New loan approvals for housing have moderated over recent months as interest rates have risen and the impact of large grants to first-home buyers has tailed off. Nonetheless, at this point the market for established dwellings is still characterised by considerable buoyancy, with prices continuing to increase over recent months.

Recent data on inflation confirm that it has declined from its peak in 2008, helped by a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand. In both underlying and CPI terms, inflation over the most recent 12 months was around 3 per cent. Nonetheless, the extent of decline from here may not be quite as much as earlier forecast and inflation now appears likely to be in the upper half of the target zone over the coming year.

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 Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of 2–3 per cent over time.

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Speaking at a business forum in Toowoomba last week, RBA governor Glenn Stevens said with the economy growing close to trend, and inflation close to target, interest rates are now falling back to normal levels.

“The Reserve Bank has moved early to raise the cash rate to levels that deliver interest rates for borrowers and depositors more like those that have been the average experience over the past 10 to 12 years,” Mr Stevens said.

“Those interest rates are now pretty close to that average.”

18 months ago, the RBA board moved quickly to establish an “emergency low” level of interest rates in the face of a serious threat to economic activity.

According to Mr Stevens, the central bank’s “aggressive” reduction in interest rates needed to be complemented by timely movement to raise rates back to normal levels once the emergency had passed.

Moving forward, Mr Stevens said the board’s focus will be on doing its part to achieve an average inflation target of about two to three per cent.

“Our task… is now to manage a new economic upswing. This will be just as challenging, in its own way, as managing the downturn. But it’s a challenge plenty of other countries would like to have,” he said.

The global economy is growing, and world GDP is expected to rise at close to trend pace in 2010 and 2011. The expansion is still hesitant in the major countries, due to the continuing legacy of the financial crisis, resulting in ongoing excess capacity. In Asia, where financial sectors are not impaired, growth has continued to be quite strong, contributing to pressure on prices for raw materials. The authorities in several countries outside the major industrial economies have now started to reduce the degree of stimulus to their economies.

Global financial markets are functioning much better than they were a year ago and the extraordinary support from governments and central banks is gradually being wound back. Credit conditions remain difficult in some major countries as banks continue to face loan losses associated with the period of economic weakness. The concerns regarding some sovereigns appear to have been contained at this stage.

Australia’s terms of trade are rising, adding to incomes and fostering a build-up in investment in the resources sector. Under these conditions, output growth over the year ahead is likely to exceed that seen last year, even though the effects of earlier expansionary policy measures will be diminishing. The rate of unemployment appears to have peaked at a much lower level than earlier expected. The process of business sector de-leveraging is moderating, with the pace of the decline in business credit lessening and indications that lenders are starting to become more willing to lend to some borrowers. Credit for housing has been expanding at a solid pace. New loan approvals for housing have moderated over recent months as interest rates have risen and the impact of large grants to first-home buyers has tailed off. Nonetheless, at this point the market for established dwellings is still characterised by considerable buoyancy, with prices continuing to increase in the early part of 2010.

Inflation has, as expected, declined in underlying terms from its peak in 2008, helped by a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand. CPI inflation has risen somewhat recently as temporary factors that had been holding it to quite low rates are now abating. Inflation is expected to be consistent with the target in 2010.

With the risk of serious economic contraction in Australia having passed some time ago, the Board has been lessening the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker. Lenders have generally raised rates a little more than the cash rate.

Interest rates to most borrowers nonetheless have been somewhat lower than average. The Board judges that with growth likely to be around trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today’s decision is a further step in that process.

The results were like looking at the school report of a troubled teenager: “Much improved. Could do better. Would help if the student did some homework once in a while.”

Even if you slept through economics at school, you now have the chance to do a free refresher course. In the next 18 months we’ll all be going through a (real world) economics exam – get it wrong and the ramifications will be much worse than a scolding from your mum.

See below to take the test yourself

Questions:
1. After four years of reading the Barefoot Investor column and listening to me bang on about the dangers of debt, you finally decide to do something about it. The quickest way to achieve this is:

(a) By negotiating a lower rate on your debts, and increasing your repayments.

(b) By getting a line of credit – set up by a friendly telemarketer who called while you were watching Today Tonight.

(c) By cutting up your credit cards.

2. On reaching university you take up a student banking package that includes a credit card with a small, manageable limit. As long as you’re responsible and pay it off each month, will this aid in establishing a positive credit record down the track?

(a) Yes.

(b) No.

3. You see an ad in the paper for a home loan offering an attractive rate of 9 per cent. Next to the figure is the “comparison rate” of 9.75 per cent. The comparison rate means:

(a) The average rate of comparable home loans currently on offer in the market.

(b) The true interest rate you’ll pay after the ongoing and establishment fees are factored in.

(c) The interest rate you’ll pay if you choose to fix your rate.

4. The unthinkable happens and your bank goes belly up. Is the money in your account insured against loss?

(a) Yes.

(b) No.

5. The Reserve Bank has just lowered official interest rates by 1 per cent. This was designed to:

(a) Make sure property continues to double in value every seven years.

(b) Make sure the banks remain profitable.

(c) Stimulate the economy in light of the global economic slowdown.

6. You slap on the gold watch, sandals and socks, and point the Commodore to the Gold Coast. The $300,000 you’ve accumulated in superannuation will provide you with roughly how much income per year in retirement?

(a) $34,000.

(b) $24,000.

(c) $18,000.

7. As an investor there are only two things within your control that ultimately determine the bulk of your investment returns. They are:

(a) The asset class you choose to invest in, and the fees you pay.

(b) The fund manager you choose, and their track record.

(c) The movement of the share market, and your trading strategy.

8. You decide to set up a nest egg (earning 8.5 per cent) for your soon-to-be-born baby, kicking it off with $5000 and regularly investing $100 a month. After 18 years you’ve contributed $26,600, but what’s the total value of your investment?

(a) $73,700.

(b) $51,820.

(c) $37,850.

9. You buy a gas-guzzling six-cylinder Ford Falcon so you can tailgate Toyota Prius owners in suburban shopping centres. Taking everything into account (financing, depreciation, servicing, rego, insurance, fuel, tyres), how much does it cost a week to run?

(a) $175.95.

(b) $242.47.

(c) $309.45.

10. Your father tells you he bought his first car for about the same money you dropped on a three-day bender in Adelaide. With inflation driving prices up around 3 per cent a year, how long will it take for prices to double?

(a) 12 years.

(b) 14 years.

(c) 24 years.

11. You’re adviser calls and suggests you need to diversify, given that your share portfolio consists of Adultshop.com (last trade $0.008) and Amazing Loans (currently suspended for failing to lodge their accounts). To be a fully diversified investor you’ll need to:

(a) Invest in shares from a range of industries and sectors.

(b) Invest in both local and international shares.

(c) Invest across a range of different assets.

12. Your brother Phil, a nail beautician by trade, tells you about a hot investment tip he overheard at the salon. After you do some research, you see that it’s advertised as having a return well above market rate, and no risk. You decide to:

(a) Invest lightly and see how it goes.

(b) Consider it too good to be true and not invest.

(c) Invest heavily and maximise your return.

Answers
1 A. If anyone calls you while you’re watching Anna Coren, hang up on them.

2 B. Don’t fall for that old bankers’ tale.

3 B. But remember: while comparison rates are helpful, they don’t include the exit fees the banks hit you with.

4 B. But political pressure may change this.

5 C. And economists are predicting we may see some more stimulation this year.

6 B. Home brand dogfood will do.

7 A. Mention this to the next financial salesperson who tries to pitch you.

8 A. Teaching your child first hand the power of compound interest is probably the best thing you can do for them.

9 B. The Prius will give you better fuel economy – just don’t expect to drag anyone off at the lights.

10 C. Just use the “rule of 72″; 72 divided by 3 (the interest rate) gives you 24 years. This works for any financial calculation.

11 C. Warren Buffett says diversification if for wimps. But he’s smarter than you (and me), so play it safe and spread your eggs.

12 B. The ANZ survey asked a similar question and found that over half of respondents were prepared to risk their cash. Perhaps that explains why the ABS found that Australians lost nearly $1 billion last year to frauds and scams (although at that rate we’re still $729 billion ahead of the Wizards of Wall Street).

How did you go?
(0-3) Congratulations! You’ve won an all-expenses-paid holiday to the Gold Coast, where you’ll be among a select few investors to learn about an exciting investment strategy called Time Share Accommodation.

(4-6) I’m not going to beat around the bush – your score ranks you below average. The only people in finance who get away with being consistently below average are fund managers. They trouser billions a year in fees that come from the retirement balances of people like you.

(6-9) Solid performance. One suggestion: if you’re into retail managed funds, take a look at Australian Foundation Investment Company (ASX: AFI) and Argo Investments (ASX: ARG), noting their historical returns and the fees they charge (see question 7).

(9-12) Hey I’m impressed – you scored a higher mark than me when I did a second read through of the questions!

Tread your own path!

The ANZ Bank expects interest rates to fall to 4.5 per cent by the middle of next year.

Earlier this month, the Reserve Bank of Australia (RBA) cut the cash rate by one percentage point from 7 to 6 per cent.

Financial markets are expecting official interest rates to fall below 4 per cent by March next year.

But the head of Australian economics at the ANZ Bank, Warren Hogan, does not believe rates will fall that much.

“They are pricing in a very rapid reduction in interest rates, a 75 basis point rate cut in November and followed up by another in December [and] a total of 200 to 225 basis points of rate reductions by the end of our summer,” he said.

“The cash rate is expected to around 3.75 per cent by March in terms of current market pricing.

“I think that’s where the consensus of economists is settling somewhere between 4.5 and 5 per cent.

“The RBA needs to take interest rates down quite aggressively over the next six months but not to the extent suggested by market pricing at the moment.”