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By Sophia Rodrigues
     SYDNEY (MNI) - The Reserve Bank of Australia suspects the local dollar may
depreciate more than expected, and that unemployment and inflation goals may be
met more quickly, raising the possibility that the first hike in its cash rate
since 2010 might come sooner than the market assumes.
     The RBA says the next move in the cash rate is more likely to be up, but
that any hike will be contingent on what should only be gradual progress towards
unemployment and inflation goals and that it does not see a strong case for any
near-term monetary policy adjustment.
     No economist forecasts a hike this year, and the market is not pricing one
in. But there is little clarity further ahead about the RBA's timeframe for
raising the cash rate from 1.5%.
     The RBA has kept its timing vague for two reasons.
     It is unsure whether its unemployment and inflation forecasts are too
conservative. Labour force and inflation data over the next few quarters will
give it a better sense of where it stands.
     The exchange rate is also a key variable. If the Australian dollar
depreciates relative to the RBA's assumptions in its August Statement on
Monetary Policy, it raises the possibility of an earlier-than-expected hike.
     The RBA's characterizations of both these risks suggest it thinks an
increase in the cash rate might occur earlier than the market is pricing in.
     In its August Statement on Monetary Policy, the bank's key forecasts for
the economy were based on the prevailing exchange rate -- $0.74 for the
Australian dollar and a trade-weighted exchange rate at 64.0, but its discussion
of risk focussed only on depreciation.
     In contrast, in May the RBA had addressed the possibility of a higher
exchange rate, saying that a "significant appreciation of the Australian dollar
would tend to dampen future output growth and inflation."
     For the first time, the RBA in August clearly laid out the risk that U.S.
growth could be stronger than expected, which might lead to the Federal Reserve
increasing the federal funds rate by more, or more quickly, than anticipated.
This could strengthen the U.S. dollar, while more robust global demand and a
broad-based depreciation of the Australian dollar would tend to boost both
domestic activity and tradables inflation, the RBA said.
     The RBA also suspects its forecast for the fall in the jobless rate might
be too conservative, which could mean that the forecast for inflation has erred
on the low side as well.
     The RBA expects unemployment to gradually move lower but touch 5% only by
the end of its forecast period in December 2020. With joblessness dropping to
5.3% in the July labour force survey, 5.0% could be reached well before then.
     While the RBA has acknowledged uncertainty over whether 5% is still
consistent with full employment, if the level is breached, pressure on wages
would nonetheless tend to increase, increasing the chances of inflation rising
faster than the bank's forecast too.
--MNI Sydney Bureau; tel: +61 2-9716-5467; email:
[TOPICS: MMLRB$,M$A$$$,M$L$$$,MX$$$$]

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