RBA left the cash rate unchanged at 6.5%

RBA left the cash rate unchanged at 6.5%

As expected, the RBA today left the cash rate at 6.5%, following yesterday's Board meeting. The 'no change' decision follows a 25bp hike in August, which marked the ninth such increase to the cash rate in this extended tightening cycle that started back in mid-2002.

While the RBA will likely sit on the sidelines in coming months, allowing time to assess the impact of last month's rate hike and ongoing developments in global financial markets, the current tightening cycle appears to have further room to run. Robust domestic conditions, a healthy global backdrop (even after accounting for the recent volatility in financial markets), and the anticipated acceleration in headline inflation in coming quarters (possibly above the top end of the RBA's 2-3% target range), suggests that another near-term interest rate hike will be warranted.

On the domestic front, upward pressure on inflation continues to build. Food and energy prices are trending north owing to the drought, rent and construction costs remain high, wage pressures are building amid multi-decade low levels of unemployment, crude oil prices remain elevated, and the AUD has come away from its 18-year highs vis-Ã -vis the US dollar (meaning that import prices may soon start to rise). Moreover, the national accounts data released yesterday showed that annual GDP growth accelerated in the June quarter to 4.3% from 3.8% in Q1, remaining well above potential. The widening gap between the economy's actual and potential growth rates means that inflation pressure will continue to build, especially given the economy continues to bump up against capacity constraints.

JPMorgan maintains its forecast that the RBA will hike interest rates by another 25bp in December, following the Federal election (expected to be held in November). That said, Governor Stevens and his board will keep an eye on financial market developments and on the lookout for any signs that the current credit rout is starting to have a negative impact on underlying economic fundamentals. In the statement that accompanied the RBA's decision to hike rates in August, the board acknowledged the turbulence in global financial markets but indicated that, while the developments pose a downside risk to the US economy, they do not appear to have changed significantly the broader global outlook. As such, in the absence of any deterioration in economic fundamentals, the RBA will likely tighten policy again in 2007, even if the Fed eases. An RBA rate hike after a Fed ease would not be unprecedented. In 2002, the RBA embarked on a tightening cycle when the Fed was still on the way to lowering the funds rate to a record low of 1%.

ENDS

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