This strategist says the RBA is running out of reasons to keep interest rates at record-lows

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The Reserve Bank of Australia (RBA) is quickly running out of reasons to keep interest rates at record-low levels, and should local economic data continue to improve as it has done in recent months, including an uptick in inflationary pressures, the risk is that it may deliver a hike far sooner than what many currently expect.

That’s the view of Annette Beacher, chief Asia-Pacific macro strategist at TD Securities, who says that markets are currently under-priced for the prospect of of rate hikes from the RBA next year.

“Positive data surprises have been accumulating for high frequency indicators such as retail sales, building approvals, employment and commodity prices in recent months, seemingly under the radar of financial markets,” Beacher wrote in a note released on Monday.

“Last week’s CAPEX report revealed a significant upgrade to non-mining investment plans for the year ahead. Does the economy still need record low interest rates?”

To Beacher, the answer to that question is increasingly no, pointing to the likelihood that stronger labour market conditions will lead to pickup in wage and inflationary pressures in the quarters ahead, further eroding the argument that rates need to remain at emergency levels.

Following the unusually large lift in Australia’s minimum wage rate at the start of July, Beacher is forecasting that wage growth for employees in Australia’s services sector are likely to accelerate to 2.6% in the September quarter, up from 2.3% in Q2, helping to boost inflationary pressures in the period ahead.

“June quarter underlying inflation may have been a shade under the 2% [RBA’s] lower bound, but the next two inflation reports are expected to see underlying inflation return to the 2-3% target band,” she says, pointing to a sharp jump in the Melbourne Institute’s trimmed mean inflation measure in August which rose to 2.5% year-on-year, the highest level in three years.

This chart from TD shows how the Melbourne Institute figure compared to the quarterly trimmed mean measure used by the ABS.

Source: TD Securities

With labour market conditions improving, inflationary pressures starting to build and a raft of other economic indicators all pointing to a strengthening in the non-mining sectors of the economy, Beacher says theese trends will see the RBA lift rates twice next year, first in May and again in November.

“Waiting for the next two inflation reports to confirm that inflation is back within the 2-3% band sees the RBA wait at least until February before lifting the cash rate. However, we take the conservative path and pencil in a May hike to 1.75%, followed by a ‘wait and see”’ stance, before lifting by another 25 basis points in November to end 2018 at 2%,” she says.

The speed and scale of hikes expected by Beacher is certainly far more aggressive than what financial markets currently anticipate with the first move from the RBA not fully priced until November next year.

However, she’s not alone in thinking the RBA will move sooner that what many currently think.

In a note released late last week, Paul Bloxham, chief Australia and New Zealand economist at HSBC, said the RBA was likely to increase interest rates as early as February next year.

“If, as we expect, by early 2018, growth is running at an above trend pace, underlying inflation is back in the 2-3% target band and wages growth is past its trough, the RBA may see little need to maintain its highly accommodative monetary policy stance, particularly given its ongoing concerns about the exuberance in the housing market,” he said.

“We see the first hike as likely to arrive a bit earlier than the market is currently pricing.”

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