(Bloomberg) -- Australia's central bank is all but certain to increase interest rates at its first meeting of the year, with some observers pointing to the risk of a resumption of outsized moves to counter a surprising surge in inflation.
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Most economists and traders see the Reserve Bank lifting its cash rate by a quarter-point on Tuesday to 3.35%, the highest level since September 2012.
Commonwealth Bank of Australia and Australia & New Zealand Banking Group Ltd. highlight a small probability of a bigger hike, while Bloomberg Economics sees a mini 15-point move and JPMorgan Chase & Co. predicts a pause.
The RBA will weigh signs of weaker hiring and household spending against a sharp acceleration in core inflation when it discusses policy settings. In December, the board considered a half-point hike and a pause before deciding to raise by a quarter point, meaning it has looked at alternatives.
"The RBA finds itself in a tight spot, with widespread data now showing the economy is cooling, but core inflation is uncomfortably hot," said Andrew Ticehurst, macro strategist at Nomura Holdings Inc. in Sydney. "The risk would be for a larger move, rather than no move, in our view."
Governor Philip Lowe has the rare advantage of having watched the Federal Reserve's meeting last week, when it downshifted to a quarter-point hike and signaled some more tightening to come. That gives the governor a read on the global picture, with his British and European counterparts also hiking.
The consensus is that most central banks are approaching their terminal rates. The RBA is in a similar position to the Bank of Korea, where the economy is starting to cool but inflation is failing to follow the script.
That said, the RBA had forecast fourth-quarter CPI would be the peak. What they didn't predict was the underlying strength of inflation, with the key trimmed mean gauge soaring 6.9% from 6.1% in the third quarter, and higher than the RBA's 6.5% forecast.
Lowe has repeatedly said the bank is "not on a pre-set path" on rates and that it will do "what is necessary" to bring inflation back to its 2-3% target. While the bank will release updated quarterly estimates on Friday - and touch on them in tomorrow's statement - its November forecasts only showed inflation returning to target in early 2025.
What Bloomberg Economics Says...
"The central bank will probably suggest more tightening is needed, but subsequent data should convince it that it's already done enough to quell inflation"
- James McIntyre, economist
To read the full note, click here
Australia's broadening price pressures prompted CBA's Gareth Aird to see a "non-trivial" threat of a 40-point hike Tuesday. ANZ's Catherine Birch reckons "the risks are a bit more tilted to 50-basis-points" given the inflation reading.
Nomura's Ticehurst and Birch both expect the RBA to take the cash rate to 3.85% by May - a more aggressive prediction than the consensus of 3.6%. CBA's Aird forecast a pause after February's meeting.
The RBA's rate hikes have driven a downturn in the housing market that's beginning to weigh on broader activity. Retail sales fell far more than expected in December as cost of living pressures weighed on households. Employment growth is also slowing as business confidence wanes.
Lowe maintains that the RBA can bring the economy in for a soft landing and the International Monetary Fund agrees there's a good chance of that.
Indeed, with Australia's key trading partner China ditching Covid Zero and reopening, and inflation beginning to cool in other major economies, the global backdrop is improving.
Australian prices remain hot in part because the services industry that drives the economy is now rebounding strongly. The RBA is also grappling with a longer than usual lag in transmission because a substantial number of home loans were fixed when the cash rate was at a record-low 0.1%.
Economists see a pressure point in the economy when the roughly A$370 billion ($260 billion) of these loans shift to variable rates this year.
"The second quarter of 2023 is when fixed-rate mortgages start to roll off aggressively," said James Wilson, a senior fund manager in Melbourne at Jamieson Coote Bonds, which oversees about $4.2 billion. "The RBA will be cognizant of that so we may see a pause after the March meeting."
--With assistance from Garfield Reynolds.
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