MNI INSIGHT: AUD weakness, jobs could bring forward RBA hike

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%.

     --AUSSIE DOLLAR

     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.

     --JOBLESS RATE MIGHT REACH 5% EARLIER

     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: sophia.rodrigues@marketnews.com

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