Here's why the RBA is unlikely to follow Canada in lifting interest rates near-term

Tennis players Genie Bouchard of Canada (R) stands with Nick Kyrgioas of Australia (L) following their match in the Lotte New York Palace Invitational Badminton Tournament at the Lotte New York Palace in New York August 24, 2017. / AFP PHOTO / TIMOTHY A. CLARY (Photo credit should read TIMOTHY A. CLARY/AFP/Getty Images)

Earlier this week the Bank of Canada (BoC) lifted interest rates for the second time in two months, taking its key overnight rate to 1%.

“Given the stronger-than-expected economic performance, Governing Council judges that [the] removal of some of the considerable monetary policy stimulus in place is warranted,” the bank wrote in justifying its decision.

With markets divided as to whether or not the bank would lift rates heading into this meeting, the Canadian dollar surged higher in response, rising to the highest level in over two years against the US dollar.

Curiously, the Australian dollar also rallied in response, albeit by a far smaller amount that its Canadian counterpart.

Seemingly, some traders took the BoC’s decision as a sign the Reserve Bank of Australia (RBA) may soon follow in its footsteps and begin to lift interest rates.

Like Canada, Australia is a major commodity producer, and recent economic data in Australia has also been improving. And while inflationary pressures remain weak in both countries, that hasn’t prevented the BoC from raising rates with the bank confident that it will eventually move back to its inflation target.

It’s understandable why some feel the RBA may follow suit, and sooner than what most in markets currently expect. The ducks are seemingly lining up in Australia for a rate hike, at least if the example from Canada is anything to go by.

While some think that will eventuate, RBC Capital Markets doesn’t think it’s as clear-cut as that, suggesting that there’s still plenty of differences between the Australian and Canadian economies right now that will prevent the RBA from hiking rates.

Su-Lin Ong, head of Australia and New Zealand economics at RBC Capital markets, explains why:

Is Australia simply lagging the Canadian story with a weaker starting point? We are less sure and more cautious on the Australian outlook. The similarities in the transition to stronger non-resource capex, net exports, and a moderation in the housing markets are evident. However, while we have long held a more optimistic view for non-mining investment, which is slowly emerging, we have greater reservations around the outlook for household expenditure, reflecting a number of structural headwinds, with a likely cyclical slowdown in housing activity an added consideration in 2018. We also think there is ongoing downward pressure on Australian wages given the elevated currency, which is contributing to the need to be more competitive. And we expect greater divergence in major trading partner growth next year, with a likely moderation in Chinese activity in 2018 in contrast to an expected pickup in US GDP to 3%.

Ong says that Australian consumption and housing data is likely to soften in the months ahead, which, coupled with an ongoing tightening in financial conditions, should keep the RBA firmly on hold until at least the end of next year.

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