Good Morning
RBA to continue rate hikes at the February meeting.
Cash target rate to increase by 0.25% to 4%.
Since the last RBA board meeting in December 2009, when the RBA increased the cash rate to 3.75%, domestic economic data has continued to show continued strength, and outperform the rest of the Western World. Only Chinese economic data has printed better than Australian data in the past several months.
Overall the global economy is picking up, albeit at a varied pace, but with Australia avoiding a technical recession, the RBA will continue to show the lead to other Central Banks in tightening policy.
Therefore, there should be no inhibition from the RBA to continue to gradually tighten monetary policy, from an economic data viewpoint.
Having established a gradual pattern of increases, and not stalling the recovery, it appears logical that the RBA will continue their approach and increase the cash target rate by another 0.25%, taking the cash rate to 4%.
Recent Rhetoric from the RBA.
Deputy Governor Ric Battellino delivered a paper in Sydney on 16 December on Bank Funding and quantified that recent increases in Major Banks' Australian Net interest margins, had in effect added 1% to the RBA cash rate.
“Another way to think about this is that the current level of deposit rates, housing loan rates and business loan rates would have been consistent, before the crisis, with a cash rate of at least 4.75%”
“However, the Reserve Bank has taken these changing relativities into account in its monetary policy decisions.”
With the outright level of the RBA cash rate still at at an expansionary level, the comments above are considered academic as the increases in net margins has been building for more than a year, and have already been taken into consideration previously.
On 21 January, Board member Graham Kraehe, in a Dow Jones interview, said that the Australian economy is at risk of an acceleration in inflation, as a labour shortage and the resources boom push up costs.
Asked if too much policy tightening would choke off a recovery he said " The risk is more to cost pressure and inflation than it is to the demand side."
Remaining data before the February Board meeting.
There is only one major data release before the February board meeting, the 4th quarter CPI, which will be released at 11.30am today.Somewhat quizzically, the outcome may not actually have any impact on the RBA at the February meeting.
In my view, the RBA will hike next month, even if today's CPI is below forecasts of +0.6% for the important core numbers.
With the current cash rate at 3.75%, monetary policy is still at an expansionary setting, and by recent and past comments, the RBA is keen to continue to remove emergency settings. So in February it does appear that we will get a 25 point hike, on the simple grounds of returning settings to normal.
In my view, the RBA will hike next month, even if today's CPI is below forecasts of +0.6% for the important core numbers.
The CPI forecasts for Q4 2009 are for a q/q increase of 0.2% in the headline number, with the trimmed and weighted core numbers forecast at 0.6%. Those numbers should not, stand alone, prompt a tightening of policy but they would serve as a strong reminder that the RBA still needs to remove any remaining emergency policy setting, as inflation expectations are on the rise.
On the other hand, a larger than forecast inflation outcome, say +0.4% and +0.8% + for the core numbers, should not and would not, tip the RBA's hand to hike by 50 points or higher. That is not on the agenda nor are there any predications or outside guesses. As it is not in the frame, a 50 point can be ruled out.
At what level will the RBA pause?
This is an unprecedented tightening phase, so history is of no real benefit in predicting the first pause level, or indeed the terminal tightening rate. With three successive hikes, each of 0.25%, the RBA has created history, as previously they had never tightened more that two successive months.
The main clue to the RBA's likely future decisions, is the constant use of the term gradual. Other clues have and will come in RBA rhetoric, and as discussed earlier in this note, the latest was the reference by Graham Kraehe, that the risk is cost pressure and inflation.
Therefore, I hold the view that the pause rate will be around 4.5%, which means three more hikes of 0.25%. Perhaps after reaching 4%, the Bank may stagger the next two or three by a month or two. If this is the way they go, I am sure Glenn Stevens and his Board will telegraph their intentions. The RBA holds transparency in high regard.
However, it does appear that the RBA is and will be determined to continue to gradually lift the cash rate, before inflation and inflation expectations. That is expected to take the cash rate to 4.5% o maybe 5%, before they adopt a pause, which could last several months, while inflation or inflation expectations become a real event.
The Terminal Rate.
Tightening ( and easing ) cycles, eventually end and there is always interest at the level a particular cycle will end. That rate is often referred to as the terminal rate and in the dramatic easing cycle, which conclued with a 0.25% cut to 3% in April 2009, produced a Terminal rate of 3%.
It is really too early to think about the terminal rate, but given the comments of Ric Battellino that Trading Bank funding has, in effect added 1% to the RBA cash rate, my early opinion is the the terminal rate will be close to 6%, and will not be seen until well into 2011.
Summary.
At the next meeting, on 2 February, the RBA is expected to hike by 0.25% taking the cash rate to 4%, and maintain a modestly hawkish approach that suggests further rate hikes are likely. The accompanying rhetoric will hold the key of on-going rate hikes, ( gradual ), or if a stagger approach is more likely.
Current Interest rate futures pricing, basis the 30 day cash contract, is pricing currently pricing in a 0.25% hike in February, to about an 60% probability. For the March board meeting, a follow on hike shows pricing that only gives about a 10% possibility, but this will change after the February rhetoric.
Kind regards,
