Australian Interest Rate Preview

October 4, 2010

The Reserve Bank’s October interest rate decision will be revealed at 03:30 GMT Tuesday.  A majority, but not all, pundits project a 25-basis point Official Cash Rate increase to 4.75%.  The last tightening was undertaken five months ago.  It was the sixth rise since last October.  When officials earlier had feared a recession, the OCR was cut from a cyclical peak of 7.25% to 3.0%.  After the start of the tightening cycle a year ago, officials also paused between December and March.  All six rate hikes thus far were by increments of 25 basis points.  The latest pause was made in light of external growth concerns, spawned especially by the euro area’s sovereign debt problems.  These have lessened but not disappeared, and Chinese demand for Australian primary exports continues to be brisk.

Minutes from the Policy Board’s meeting in early September were rather hawkish in tone.  Economic growth is projected to expand at trend or even a bit above trend for the next several years.  Australia avoided a recession and does not have the abundance of slack resources that can be found in most other advanced economies.  The terms of trade is back near its 2008 peak; this ratio of of export and import prices correlates well with Australian income and consumption growth.  The August jobless rate of 5.1% was a 19-month low, and jobs had risen 3.2% over the prior year and at a sizzling 3.7% annualized pace over the past five reported months.  Evidence of cooler property market conditions are welcomed by officials and indeed a consequence of policy design and the six previous rate hikes.  Just because that restraint seems to be working shouldn’t deter policymakers from taking further moves toward more normal rate levels.

Those pundits, who think the policy pause will be extended at this week’s meeting, do not disagree that rates will be raised again reasonably soon, meaning by yearend.  Officials might want to peruse third-quarter CPI data due late this month before acting.  Consumer prices in the second quarter had advanced just 0.6% and 3.1% from a year earlier, fooling a street forecast consensus of gains of 0.9% and 3.4% on year.  Core inflation dipped to 2.7% in 2Q from 3% in 1Q.  Even so, inflation remains near the top of the 2-3% target range and is more likely to creep higher than lower going forward.  One gauge of expected inflation over the coming 12-months edged up to 3.0% in August from 2.8% in July.  Another deterrent to a rate hike on Tuesday could be Australia’s manufacturing purchasing managers index released just before the weekend, which fell to 47.3 in September from 51.7 in August and 54.4 in July.  That was the first sub-50 reading, that is one indicating contracting activity, of 2010.  Finally, Because of exchange rate appreciation, Australian monetary conditions have tightened even while the cash rate has stayed at 3.0%.  The Aussie dollar is 5.5% stronger against its U.S counterpart since the Policy Board met in September, and it has advanced 17% since early July.

The aforementioned minutes concluded with a forecast that rate increases will be required if the central bank’s baseline macroeconomic trend expectations prove correct.

While policy had to be alert to these [downside growth] risks, members considered that if the central scenario came to pass it was likely that higher interest rates would be required, at some point, to ensure that inflation remained consistent with the medium-term target.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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