It is refreshing to see the RBA catching up to my view about the strength of the domestic economy. In recent days and weeks, RBA officials have finally acknowledged some of the general risks to inflation associated with a clear strengthening in the non-mining parts of the economy and from what is an increasingly worrying lift in house prices.

The RBA Board meeting next Tuesday, 1 April, is likely to throw a few more hints that the current 2.5 per cent cash rate is not appropriate for the current fundamentals. The foreign exchange market understanding this as the AUD powers to 0.93 US, even though it is taking an eternity for the many strategists to roll over to the new information.

Booming double digit growth in house prices, a record high level of new housing construction, rising commodity prices, exports surging in both volume and value terms and consumer demand expanding at a solid clip are threatening to put a rocket under inflation, which has already been marching higher since the middle of last year.

Even what appeared to be a shaky labour market is no more. Employment gains are starting to pick up, and the forward indicators from the various private sector surveys suggest the unemployment rate is very close to a cyclical peak.

Which leads to the core forecasting scenario that the RBA will be looking at next week.

  • Real GDP growth lifting to 3.5 per cent by late 2014 and into 2015.
  • Inflation running at 2.75 to 3 per cent over the forecast horizon with upside risks if the labour market improvement is stronger than expected.
  • The unemployment rate to fall to 5.5 per cent, or less, by early 2015 on the back of the stronger domestic economy.
  • Global economic conditions are clearly holding at a strong pace, with policy makers in the large economies continuing to aim for growth.

And these are the mid-point forecasts. Any upside from policy being too easy for too long or a soft effort on fiscal consolidation in the budget in May would see the numbers stronger than presented here.

The end point is that the RBA realises monetary policy is too easy and as a result it is poised to hike interest rates from the historically low 2.5 per cent. My best guess is that the hike will be in May, after the RBA uses the next 5 weeks to soften up the market for such a move and after the March quarter CPI confirms inflation at the top end of the 2 to 3 per cent target band.