RBA to hike in May as market mood swings

Tue, 18 Mar 2014  |  

Despite more bank economists rolling over and flipping their forecasts for interest rate cuts into calls for interest rate hikes, financial markets are yet to price in those higher rates.

Indeed, for the next few months, the futures market is still pricing in the risk, albeit a low one, that he RBA could still cut interest rates.

A factual interpretation of market pricing is effectively for the RBA to be holding interest rates steady for at least the next year. If this turns out to be correct, it could be the longest period of interest rates on hold on record, noting that it is already 8 months since the last RBA interest rate adjustment.

As such, the market pricing seems wrong. An interest rate hike is likely to be soon, perhaps very soon, given the run of quite dynamic economic news that has been flowing in recent months.

The question now being discussed with gusto within the RBA is whether a 2.5 per cent cash rate is appropriate.

The answer is obviously a resounding "no" given the facts that inflation is picking up, exports are booming, consumer spending is strong, dwelling construction is hitting record highs and now the labour market is on the brink of registering solid jobs growth with a falling unemployment rate.

If the additional information of massive house price growth, rising commodity prices and a low Australian dollar are thrown into the mix, the RBA decision to hike is a no-brainer and one that should be implemented very soon.

It must also be noted that global economic conditions are strong, with the US growth momentum solid, China easing policy to soften the risks it is confronting, while India and the Eurozone are reversing the poor news from 2013.

My hunch is that the RBA will be acting to hike interest rates in May. Arguably it should have hiked already, but a few month delay in the inevitable is neither here nor there. The RBA probably needs a bit of time to keep softening up the market for such a move but the reversal of views from Westpac and others on interest rates will help the RBA in this task.

By this time next year, the cash rate is set to be about 100 basis points higher than now – at around 3.5 per cent which is likely to coincide with the Aussie dollar back near parity.

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