RBA to Hit the Brakes

Remember a while back, when I pointed out that things were looking bright for the Australian economy, causing the Reserve Bank of Australia to become more hawkish? Well, it looks like the bullish sentiment towards the Aussie is now coming to an end as the minutes of the latest monetary policy meeting hinted at possible rate hike pause!

For those of you keeping score at home, the RBA had actually bumped up the rate six times already, up to 4.50% now from its low of 3.00% during the middle of last year.

According to RBA Governor Glenn Stevens, interest rates are at levels exactly where the central bank wants them for now. Stevens said that the string of rate hikes is now affecting consumer behavior and it’s time to sit idly and go back to a “wait-and-see” approach. With that said, many traders aren’t expecting a rate hike come June.

Comments from bank officials are useful and all that, but what are the numbers saying?

Let’s start with Australia’s consumer price index, which is the most important report when it comes to gauging overall inflation. The most recent CPI showed that the country’s inflation rose to 2.9% during the first quarter of 2010, which was a significant jump from the previous quarter’s 2.1% increase. Despite the increase, inflation was still within the RBA’s 2-3% target.

Another measure of inflation, Australia’s producer price index, hinted that the RBA could keep rates at the 4.5%-5.0% range until the end of the year. The PPI released last March actually revealed a decrease of 0.1% year-on-year.

Still, some pundits are saying that the sharp rebound in Australia’s house prices could potentially lead to a housing market boom and push the RBA to raise rates further. The country’s house price index released last week reported an unexpected surge of 4.8% in the selling price of homes, marking its fourth straight month of increase.

“So, Forex Gump, where do YOU think interest rates are headed? And what does this mean for the Aussie? After all, that’s what we traders care about!”

In this old man’s humble opinion, speculation that the central bank would keep rates on hold has probably been priced in more than a month ago, when RBA Governor Glenn Stevens first remarked that rates are nearing their normal levels. If the RBA does keep rates on hold in June, we might see only a mild reaction from the Aussie.

Of course RBA policymakers are also wary about the possibility of debt contagion and the impact of the euro zone’s ginormous bailout package. Although Australia is likely to stay resilient amidst threats to global financial instability just as it successfully dodged the recession bullet last year, the RBA might be better off taking a cautious wait-and-see stance for now.

But with annual inflation skirting dangerously close to the top of the RBA’s target range, the central bank might be forced to resume their rate hikes by the second half of the year. Despite the increase in borrowing costs, it seems that Australia’s strong economic activity is unfazed by these tightening measures. The RBA even upgraded its growth forecasts for 2010 and noted that inflation could linger at the top of their target range for the next couple of years.

At the end of the day, the Land Down Under still has a more stable economic footing compared to the other major economies. With that said, the prospect of the RBA’s benchmark rate reaching 5.00% isn’t so absurd after all… but we might have to wait until the end of the year for that.