Interest rates tipped to remain on hold, but for how long?

Economists are almost unanimous in their opinion that the Reserve Bank of Australia will keep official interest rates on hold at 4.5% when its board meets tomorrow, however the looming spectre of inflation is still likely to lead to another rate rise before the end of the year.

While some commentators have suggested that the on-going European debt crisis and fears of a second recession in the US could lead the RBA to consider cutting rates tomorrow, the safer bet is that the RBA will leave rates on hold while it tries to get a clearer picture of where the Australian economy is heading.

While consumer spending and business profitability remains sluggish, strong growth from the mining sector means the economy appears on track for a strong recovery into 2011.

The dreaded spectre of inflation remains the RBA’s biggest worry. An inflation gauge released this morning by TD Securities shows inflation rose 0.3% from May to June, and is now running at an annual pace of 3.6%.

That is slightly down from the 3.7% annual rate see in May, but still a long way outside the RBA’s long-term target band of 2-3%.

TD senior economist Annette Beacher says all eyes will now be on official inflation data for the June quarter, which will be released on July 28.

TD Securities is expecting an increase of around 1.0%, lifting the annual pace of inflation to 3.4%.

“While there are lingering concerns about a fresh wave of negative offshore headwinds, another uncomfortable CPI report will be released at the end of the month, refocusing attention to Australia’s unique position of relative economic strength,” she said in a statement.

“We believe this inflation news will be a key tipping point for the RBA to upwardly adjust the cash rate by 25 basis points to 4.75%, perhaps as soon as August.”

That echoes the opinions of most economists, who are tipping at least one more rate rise this year and a few more in the first half of calendar 2011; the consensus is that rates will be at around 5.5% by the middle of next year.

ANZ chief economist Warren Hogan is one of those predicting a pause for the next few months before some movement at the end of the year.

“Over the longer term, the risks to the inflation outlook remain to the upside, particularly due to the forecast boost to income flows over coming quarters as a result of a stronger terms of trade. As such, we forecast rate hikes towards the end of the year will see the cash rate reach 5% by December.”

However, the situation clearly remains fluid. Interest rate futures markets are predicting no rise before the end of the year, and have even priced in the possibility of a small cut if the global recovery continues to stall as it has in the last few months.