Special Report-The RBA is expected to hike rates Tuesday
Monday, May 3rd, 2010The Reserve Bank of Australia (RBA) will hold a policy meeting on Tuesday, May 4th. The RBA hiked rates 25bps in April and in the policy statement left the door open for future rate hikes. According to the April RBA policy statement the global economy is growing, Australian growth is close  to trend, global financial markets are functioning better, inflation has risen and interest rates remain somewhat below average. The RBA has raised rates by 125bps since October with current overnight rate at 4.25%. There are a number of factors that point to a 25bps point rate hike by the RBA Tuesday. Recent Australian economic data confirms improving domestic growth and rising inflationary pressures. Australia’s GDP grew at its fastest pace in two years rising 0.9% in Q1 as consumer spending has been strong. The Q1 inflation rate rose by 0.9% compared to 0.5% in the fourth quarter. Australian employers have created more than 200k jobs over the last five months and the unemployment rate is at an 11 month low of 5.3%. Australia’s industrial activity surged in Q1 rising at its fastest pace in two years. Australian swap rates rose to an eight-month high Monday and implied forwards predict a 70% chance of an RBA rate hike Tuesday up from 55% Friday. The rise in swap rates increases the odds that the RBA will raise rates.
 Recent statements from RBA officials point to increased risk that the RBA will hike rates Tuesday. RBA Governor Stevens said that Australian economy is running near trend and he indicated that central bank wants to move interest rates closer to the normal average. According to Stevens normal average is 4.5% to 5%.Stevens also said rates are now pretty close to average so his rhetoric is not all that hawkish. The RBA Deputy Governor Debelle said that the RBA takes lending rates into account when setting interest rates and he noted that mortgage rates were rising. In addition, RBA officials have expressed concern about rising Australian house prices. Monday Australia reported that Q1 house prices rose by 4.8%. The sharp rise in Q1 Australian house price index tips scales in favor of a 25bps rate hike Tuesday.
 There are two considerations that may encourage the RBA to hold rate policy steady. The first is concern about the impact of the Greek debt crisis. Debelle says that Australian funding costs haven’t been affected by the Greek crisis. If RBA officials conclude that the risk of a Greek contagion is a bigger threat they may elect to hold rate policy steady. Investors sold the EUR Monday on concern that announcement of a €110bln EU/IMF bailout for Greece may not contain the EU sovereign debt crisis. The RBA may come to a similar conclusion. The second concern is tightening of policy in China. Sunday China raised its bank reserve ratio requirement by 50bps for the third time this year. The RBA paused in its rate hike cycle in February partly because of tightening of monetary policy in China at the start of 2010. The RBA suggested that tightening in China was doing the job for the RBA. The outlook for the global economy in February was less certain. Since February economic data particularly from China and the US confirm improving outlook for the global recovery. The likelihood that tightening in China prevents the RBA from hiking rates Tuesday is low because of the general strength of the global recovery.
 We expect that the RBA will raise rates 25bps at Tuesday’s meeting to continue the normalization of RBA rate policy and to eventually get rates back to 5% by year-end. This would mark the sixth rate hike by the RBA in seven policy meetings. The impact of the RBA rate hike will depend on the RBA policy statement and whether the RBA signals a pause in the rate hike cycle or a plan to continue to move towards normalization of interest rate policy. A 25bps RBA rate hike has likely been discounted by current AUD rally and the AUD may be vulnerable to buy rumor sell fact liquidation pressure after the conclusion of the meeting. AUD could experience moderate short-term selling pressure if the RBA signals a pause in its rate hike cycle. Based on the analysis above it would be a mild surprise if the RBA elected to hold rate policy steady Tuesday. Steady RBA rate decision could spark a bigger AUD sell off.
Written by Easy-Forex
