prepare for rate hikes, page-2

Interest rates are now primed

* Terry McCrann
* From: Herald Sun
* May 04, 2011 12:00AM

Glenn Stevens, governor of the Reserve Bank of Australia. Picture: Getty Images Source: HWT Image Library

BE very clear: the interest rate decision will go 'live' at the next Reserve Bank meeting in June. And right now, the outcome would be a rate increase.

Indeed, that could even be signalled on Friday when the RBA releases its quarterly statement on monetary policy
- and critically, its forecasts for inflation.

The new forecasts will almost certainly point to inflation going above the 3 per cent policy ceiling either towards the end of this year or in 2012. That would demand a policy response, and if so sooner rather than later.

It would be puzzling, to say the least, for the RBA to signal policy failure and then sit on its hands at the next immediate meeting. Apart from anything else, what would the governor's post-meeting statement say?

The qualification is that as the events in another context on Monday showed, we live in a fast-changing world. There's a lot of water that can pass under - and indeed over - the proverbial bridge in the next five long weeks.

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So the prediction of a rate rise out of the next meeting is predicated on the assumption that we don't get a shock left-field disaster, and that "events" broadly develop as now seem likely.

What we got out of yesterday's meeting was a statement by RBA Governor Glenn Stevens in two parts and carefully shaded.

There was a tendency by market commentators to misread the first part and not to see the shading - leading to their conclusion that it all marked only a slight shift in the RBA's policy stance from previously, and so that it was still 'pointing' to the first likely rate rise towards the end of the year.

Even rate hawks like former R Banker Paul Bloxham suggested the first rise would be in July-August, and more likely the later month, while CommSec's Craig James black-inked: "In short, there is no justification to lift rates, and no inclination to lift rates in the near future."

They could, of course, prove to be right. But - that "water" issue aside - I doubt it.

If conditions changed to "postpone" a rate hike, the change would also make a rate hike less likely, to the point of not happening at all.

That's to say, if we don't get a rate hike in June, possibly stretched to July, we probably won't get one later at all, because the global 'downer' scenario will have kicked in.

The key shading in the statement was the necessary stepping back by the RBA from the mildly restraining steady-state rate stance of recent rhetoric, deemed appropriate for an inflation outlook which was now "no longer operative" -- but a stepping back that did not go either straight to 'code red' on inflation, or more simply "announcing" we had to have a rate hike without then actually having a rate hike.

This shading played out in the second part of the statement, which was key: that underlying inflation had now bottomed, and even with the strong Aussie dollar (my emphasis), inflation was going to kick up.

It's where it is going to 'kick up from' that's key - at best around 2.5 per cent; arguably, from some point already above 3 per cent.

Either way, that would require a policy response and, critically, a pre-emptive one. Because if the world developed as expected, and indeed the momentum was already locked in, the horse will have bolted by the time we get to see the next inflation figures at the end of July.

They would then show that an RBA which has been broadly ahead of the game over the crucially important and also very difficult period of the last three years was now badly behind the game.

I suggest the commentators crucially misread the import of the first part of the statement -- which pointed to all the uncertainties pulling the outlook in opposite directions.

Yes, that and the strong Aussie dollar has bought the RBA time to ponder how it is all going to play out.

But it does not mean the RBA can sit on its hands indefinitely.

Last week's shock inflation figures completely changed not simply any realistic perception of the dynamics of inflation, but the balance of risk for the RBA and, crucially, the time frame.

This sentence -- "Over the longer term inflation can be expected to increase somewhat" -- might seem relatively anodyne.

While this is not a specific lifting of the RBA's inflation forecasts, you need to understand that before last week's CPI numbers, it was forecasting that both headline and underlying inflation would hit the 3 per cent ceiling by the end of 2012.

Its forecasts of both measures, running at 2.75 per cent before that, hardly provided a robust margin of error.

So the statement's closing sentence becomes key, and pregnant with much greater meaning than would appear on the surface.

The board will continue to assess carefully the "evolving outlook for (growth and) inflation."