MNI ANALYSIS: Why 2018 RBA Rate Hike Bet Might Be Justified?

By Sophia Rodrigues

     SYDNEY (MNI) - The Reserve Bank of Australia recently strengthened its

forward guidance on monetary policy and could be suggesting some possibility of

a cash rate hike later this year. While there are several upside and downside

risks, the key upside risk is outlook on the global economy which could put

downward pressure on the exchange rate.

     For the money market, this could mean pricing up to a 50% chance of a 25bps

hike by November is a fair bet, at least for now.

     Those bets could fade or increase in the next few months, depending on

global developments, macroeconomic data and financial conditions. But as things

stand, the RBA may be comfortable with the market keeping alive bets for a rate

hike this year.

     Speaking earlier this month, Governor Philip Lowe suggested more confidence

in his view that the next move in interest rates will be up, not down. He cited

two reasons: the economy is moving in the right direction as far as growth,

unemployment and inflation are concerned, and rates are still quite low.

     Last week, during a Q&A session, Assistant Governor Christopher Kent

prefaced Lowe's message: "the Governor has made it very clear that even though

we're making progress on bringing unemployment down and inflation up, that

progress is very gradual. That means, that progress means, the next move is more

likely to be up than down, but the gradual part of it means not anytime soon."

     --NO RUSH

     With more conviction now that the next move in interest rates is up, the

focus shifts to what the timing of the first hike could be. Lowe said "the board

does not see a strong case for a near-term adjustment of monetary policy," but

added, "We will, of course, keep that judgement under review at future

meetings."

     Kent conveyed the same message as Lowe with the slightly different choice

of words "not anytime soon."

     An analysis of the RBA's language suggests it sees a case for a rate hike,

even though the case might be very weak. But the language "not anytime soon" or

"not a strong case for a near-term adjustment of monetary policy", might mean

that a strong case could be made by the end of the year if upside risks pan out.

     There are two reasons why the RBA may not want the market to dismiss

possibilities of a hike this year. The key reason is the upside risk to its own

central forecast for the global economy that has the potential to put downward

pressure on the exchange rate and the second is that interest rates are "still

quite low." 

     --GLOBAL RISK TO UPSIDE

     In the February policy statement, the RBA cited the global economy as the

key external risk to its forecast, characterizing it as a mainly upside risk.

     Stronger global demand would boost Australia's exports and the risk of

faster-than-expected tightening in monetary policy in advanced economies would

put downward pressure on the exchange rate, thus boosting the economy and

raising local inflation, the RBA said. Significantly, it said the greater

financial linkages means the exchange rate effect may be more important for the

local economy. 

     It may be noted that in recent months, the RBA has been putting increased

emphasis on the trade-weighted exchange rate, rather than just versus the U.S.

dollar. So while there is a risk that the Australian dollar remains elevated

versus the U.S. currency because of entirely a greenback story, the TWI could

depreciate if global central banks tighten policy faster than expected.

     If such an upside risk that pushes the TWI lower materializes, current

interest rates in Australia might appear very low relative to where the nominal

neutral rate, estimated at 3.5%, is. That wide gap could prompt the RBA to start

the hike cycle this year.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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