Investment bank Goldman Sachs JBWere has made a big call, predicting there won’t be a rate rise in Australia next year because of the worsening prospects for the US and world economies, the continuing upward pressure on market interest rates and the fact that risk levels are now at or near record highs.

Goldman’s new forecast is important because it was one of the first (along with Merrill Lynch) to predict that the tax cut packages and other spending plans in the early weeks of the election campaign would tip the odds towards a November rate rise by the RBA, especially after the September quarter inflation figures revealed a sharp rise in core price pressures.

The Reserve Bank board meets next Tuesday for the last time this year.  Its decision will be made known Wednesday morning, two hours before the September quarter’s national accounts are released.

In a note to clients overnight the investment bank said:

Our Australian risk monitor index (ARMI) has spiked to its highest level since 9/11 and has exceeded the levels obtained at the height of the LTCM crisis.

We have formally removed our Q1 2008 interest rate hike and expect the RBA to retain its tightening bias but leave interest rates on hold in 2008.

If there is one constant in the RBA’s approach to monetary policy it is that in times of high uncertainty the best course of action is to do nothing at all.

Last night (Tuesday) our US economics team indicated that the risk of a US recession is between 40-45% on the condition that the Fed cuts rates to 3.0% by mid-2008. Should the Fed not cut rates as fast or as much as we anticipate then the risk of recession escalates.

In the context of where other central banks have stepped back from rate hikes, and the Fed looks set to cut rates, the RBA has successfully tightened financial conditions to the most restrictive level since the mid-1990s. Higher funding costs for banks may yet see a de facto rate rise in coming weeks and the key stimuli for Australia’s recent growth performance are beginning to dissipate.

Inflation pressures will remain uncomfortably high in 1H2008, however much of the inflation momentum is being driven by supply-side issues rather than demand. Ultimately, the RBA will subordinate near term domestic inflation pressures to US recession risks.

The change from Goldman’s US analysts was dramatic, with Chief Economist Jan Hatzius predicting that the Federal Reserve will have to slash interest rates to 3% by the middle of next year to head off recession.

His forecast was made before the speech by Fed Vice Chairman, Don Kohn in New York overnight, where he all but announced the Fed would cut rates at its December 11 meeting.