RBA raised cash rate 25bp as expected

RBA raised cash rate 25bp as expected

As expected, the RBA today announced a 25bp rise in the cash rate to 6.5%, following yesterday's Board meeting. Today's rise is the ninth in this extended tightening cycle that started back in mid-2002, but the first since last November. This is the first time since the RBA gained full independence in the mid-1990s that the bank has tightened policy in the months leading into a federal election, which probably will be held in November.

The JPMorgan forecast is that the RBA's job is not yet over - we expect another 25bp tightening in December (i.e. after the election) - owing to clear evidence of robust domestic economic growth, a healthy global backdrop (even after accounting for the recent volatility in financial markets), the higher starting point for core inflation in Q2 (mentioned today in the RBA's statement), and the likely acceleration in headline inflation in coming quarters. In particular, food and energy prices are rising sharply owing to the drought, crude oil prices remain elevated, and the booming domestic economy continues to bump up against capacity constraints, which the long investment boom has only partly alleviated.

The RBA's short statement announcing the rise in the cash rate provided little that was knew but, importantly, also included nothing to suggest that the RBA's job is finished. The statement ticked all of the boxes in terms of evidence of the firm domestic economy - high rates of capacity utilization, low unemployment, high business and consumer confidence, and rising demand for finance. The only mitigating factor, according to the RBA's statement, is some dampening impact of the high AUD, which has dropped 3% in trade weighted terms in recent weeks. The statement mentioned moderate wage growth as one reason the RBA has been inactive since November, but anecdotal evidence indicates that wage pressure is building.

Crucially, on inflation, the RBA's statement acknowledged unexpectedly high underlying inflation, the deterioration in the near term inflation outlook, and the higher Q2 starting point for any further acceleration. Interestingly, the statement acknowledged the turbulence in global financial markets, but indicated that while these developments pose a downside risk to the US economy, they do not appear to have changed significantly the broader global outlook. RBA officials continue to believe that high commodity prices remain an important source of stimulus for the Australian economy.

The RBA is likely to use Monday's Statement on Monetary Policy to explain in greater detail the reasons for today's tightening, but the tone of the commentary will mirror that in today's announcement. We expect the RBA on Monday to leave the core inflation forecast unchanged at 2.75% (in the upper half of the 2-3% target range), which will leave open the door for further tightening later this year. Given the upbeat tone of today's statement and, in particular, the more hawkish comments on the inflation outlook, the risk is that the RBA is forced to move earlier than December.

Attached is a weblink to the full RBA statement.

http://www.rba.gov.au/MediaReleases/2007/mr_07_11.html

ENDS

See... Full release with chart (PDF)

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