The RBA poised to hike interest rates in 2014
The odds favour the RBA hiking interest rates in February or March 2014 and that by the end of 2014, the cash rate will be about 100 basis points higher at 3.5%.
It’s a climate where the Australian dollar is more likely than not to rise, with a move back above 95 cents, or even parity on a good day, in the offing.
The Australian economy is picking up in all the right areas – housing construction is booming, retail spending is accelerating, perhaps a little too rapidly, business expectations for sales and profits are buoyant and the global economy is looking stronger by the day. Lovely news on US jobs and Chinese trade over the weekend continued to flow of good global news.
The current low level of interest rates is no doubt feeding into these positive domestic dynamics, but so too is the lower Australian dollar which is helping to fuel solid export growth.
What’s more, fiscal settings are actually stimulatory, not by much, but by a little and for the first time in a couple of years, the public sector will be adding to growth which means that just about everything other than mining investment will be rising in 2014.
The RBA is misreading the economy, in the opposite way it did in 2011 and much of 2012 when it thought the Chinese economy and mining activity wouldn’t slow much. As a result, it was too slow to cut interest rates. Now it reckons the global economy will remain subdued and that the non-mining parts of the economy will only muddle along over the next 12 to 18 months. Let’s hope it is not slow to hike interest rates.
Recall that in 2011 and early 2012, the RBA got it wrong and it changed tack under a torrent of news of a weaker economy with very low inflation. It was even forced to play catch up with an unusual 50 basis point interest rate cut in May 2012 when the penny finally dropped that the economy was indeed sluggish.
A similar thing is brewing now. In recent weeks, the RBA has retained a bias to cut interest rates, based not on facts so much, but its forecasts and assessment for the economy over the next year or two.
It is important to recall that the RBA is made up of mere mortals – very good economists – but mere mortals nonetheless. Even the best economists can get things wrong from time to time and I suspect the RBA is nearing that zone now.
Once we have a few more months of solid news on the economy and jobs growth moves higher, the RBA will no doubt change its view and deliver a series of interest rate hikes.
With house prices rising at an annual rate of 10% with few signs of cooling, dwelling construction powering to record highs, the low dollar adding somewhat to inflation and bottom line economy growth poised to lift appreciably next year, a 2.5% cash rate is clearly too low. It is the wrong policy setting for the current outlook.
The RBA will need to hike interest rates during 2014, perhaps by 100 basis points or so over that time.
From a trading perspective, I would stay short the whole IB curve, but particularly the first half of 2014 which is still pricing in a chance of rate cuts early next year. And as far as the Aussie dollar goes, it is an unusually tough call right now, but given the drover’s dog is bearish and there has been some appreciable lightening of AUD holdings from foreign investors in recent times, my view is a tick up to US 95 cents or perhaps parity is more likely than not.
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