Economy improving, rates must go up: Glenn Stevens

THE world economy is on the mend and unemployment will not reach the worst fears of the Federal Government, but that could just mean borrowers should brace themselves for a 2 per cent rise in interest rates.

Reserve Bank boss Glenn Stevens has told a parliamentary hearing in Sydney that while he does not expect rates will shoot up by that margin overnight, buyers must still plan ahead.

"It used to be the practice, I thought, that certainly banks test whether the borrower could cope with a two percentage-point increase," Mr Stevens has told the House of Representatives Economics Committee hearing.

"I'm not endorsing 2 (per cent, but) ... lenders should be applying that test."

The official cash rate has been at a 49-year low of 3.0 per cent for the last few months, after a series of slashes were rushed through to combat the worst fears of the global downturn.

"Interest rates right at the moment are unusually low ... but they won't stay that low indefinitely," he said, without shedding light on when the next move might be or by how much rates could rise.

But he has called the 3 per cent level "exceptionally low" and has said the normal rate is "a good deal north".

More than 100,000 first-time home buyers have entered the housing market since last October, attracted by those low rates and by generous government grants.  Those grants are due to expire at the end of the year.

The combination has kept house prices from falling as the economy faltered near recession, although Mr Stevens said prices had tapered off compared with income levels in recent years.

Mr Stevens has told the committee hearing the world economy was showing signs of life after some months on the precipice of disaster.  "Things abroad hardly look rosy but they look distinctly better than they did a few months ago," he said.

The Australian economy has remained "resilient", with economic activity boosted by both foreign and local factors, Mr Stevens has said.  "Exports have been remarkably strong."

He has confirmed the market's belief that unemployment will rise, but not to the 8.5 per cent originally forecast in the May Budget.  And that was not just because employees were having their hours cut instead of their jobs.

"I don't think the rise in unemployment being smaller than expected so far is just because of sharing the work around, it is also the case that the weakening in economic activity has not been as great as thought at one point," he said, adding that the peak would be "noticeably less".

Government spending splurged in the early months of the global downturn, sending the Budget into a deficit in excess of $30 billion.  But Mr Stevens has said that was a "sensible" course of action which would not damage the economy.

He has also told the committee that the Australian economy could shrink in the coming months.  But the prospects for a recovery kicking in at the end of this year and on into next year remain strong.

"I think they're still good, probably better than they were, and growth will start to pick up during 2010," he said.

Soucre - Staff wrtiers NEWS.com.au (www.news.com.au)