Rate rise on the way, says RBA, but Aussie dollar could be in line for “vicious” fall

The Reserve Bank has indicated that its pause on interest rate hikes is nearing an end, saying despite problems in some sections of the economy, monetary policy must be set for all of Australia.

In the minutes of the Reserve Bank’s May 3 meeting, the RBA said while its current 4.75% rate is “appropriate” and “mildly restrictive”, the moderation in inflation looks to have run its course, and if economic conditions continue to play out as expected, higher interest rates were likely to be required.

But the market is unsure about whether this means a lift next month. ANZ says that while the central bank was continuing to “jawbone” the market to price for a more aggressive monetary policy path, a June rise is no done deal, particularly if today’s wages data come in weaker than expected.

But Westpac says it “seems reasonable that the Bank expects to be on track for an imminent rate move with no reason for any delay.”

Katie Dean, head of Australian economics at ANZ, is less bullish. She says the RBA appears to believe it has time on its side.

“Partly, this is because of the higher Australian dollar, which the RBA concedes is tightening financial conditions. And partly it reflects the timing of the expected investment boom, which is approaching, but not yet completely upon us,” Dean says.

But Dean says the market is underestimating the prospect of a near-term move, with the market tipping a less than a 50% chance of a 25 basis point rise by September, despite the RBA forecasting core inflation to rise to 3% by the end of the year.

“This leaves little scope for upside surprises in the data over the coming quarter,” she says.

Meanwhile, Westpac chief economic Bill Evans argues yesterday’s minutes should be interpreted as giving a “very strong chance” of a rate hike next month, particularly seeing the language was remarkably similar to that used last October, one month before the RBA’s last rate hike.

But moving without delay could cause problems, the economist says.

“It is our view that such a move will have an impact on the fragile housing and consumer sectors and while the momentum in the labour market appears to be intact for now there will be no strong reason for a follow up move earlier than June.”

Importantly for SMEs, the central bank acknowledged that not all sectors are going gangbusters, but said its obligations are to the nation as a whole, rather than specific sectors.

“Members noted that the significant divergences between different sectors of the economy presented challenges for policy-making, but that monetary policy had to be set for the needs of the overall economy,” it says.

And while the Aussie dollar had a good day yesterday on the back of the RBA minutes and comments by new Treasury Secretary that the currency will remain high because of Australia’s good terms of trade, some are doubtful that the record run will continue.

HSBC has warned that the Australian dollar might be vulnerable to a “vicious” decline if global risk appetite wanes dramatically.

The Aussie dollar – alongside the Canadian dollar – is seen as a “risk” currency and generally rises when sentiment is higher. It is also boosted by weakness in the US dollar, which has been kept deliberately low by the US Fed to stimulate demand.

In a note to clients, HSBC described the valuation of the Australian dollar as “extreme”, and said “any move to a risk-off scenario could see a vicious unwind” in the currency.

The Australian dollar – which reached a post-float high of more than 1.10 US cents earlier this month – was noted in the RBA minutes as partially offsetting rising inflation pressures.