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Repeats Story Initially Transmitted at 09:02 GMT Sep 22/05:02 EST Sep 22
By Sophia Rodrigues
     SYDNEY (MNI) - There is little doubt the Reserve Bank of Australia's next
move in the cash rate will be up but the exchange rate will play a key role in
the timing of that decision, meaning the first hike may take a while to happen.
     This means the money market's pricing of close to 70% chance of a 25 basis
point hike in May next year may be too optimistic. A full hike priced by August
next year may also be a bit too aggressive.
     In a speech Thursday, RBA Governor Philip Lowe strengthened his upbeat tone
on monetary policy saying that the economy looks to be on course to make further
progress in the labor market and on inflation.
     Prior to that on September 5, he said "As we make further progress on both
unemployment and inflation, we could expect the cash rate to move towards this
(3.5%) neutral rate over time." The cash rate is currently at 1.5%.
     The clear shift in tone is not just an acknowledgement of recent strong run
of positive data on the labor market, elevated business conditions and growing
signs of a pickup in non-mining business investment but also reflects the fact
that Australia isn't isolated from medium-term movements in global interest
rates.
     Despite Lowe's comment Thursday that "a rise in global interest rates has
no automatic implications for us here in Australia," that interconnectedness
means that a forward-looking central bank like the RBA needs to prepare for the
next hike.
     But the timing will be highly dependent on what the exchange rate does. If
it remains elevated it will do the job of policy tightening and delay a hike in
the cash rate.
     In recent months, the Australian dollar has moved higher, largely
reflecting a decline in the U.S. dollar. The RBA has repeatedly said that the
higher exchange rate is weighing on domestic growth and contributing to subdued
inflationary pressure and that a further appreciation would be expected to
result in a slower pick-up in growth and inflation.
     In its current expansionary monetary policy cycle that began in late-2011,
the RBA lowered the cash rate by more than what it would do normally because it
also had to offset the impact of an elevated exchange rate and the widening of
the spreads between the cash rate and bank lending rates.
     So as monetary policy shifts towards the normalization phase, and the
exchange rate remains elevated, tightening would first come via this route
before the RBA would get a chance to pull the trigger on a rate hike.
     And that could take up to a year, maybe more.
--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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