Australia Rate-Hike Debate Set to Crescendo With Inflation Data

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(Bloomberg) — The debate over whether Australia’s central bank needs to tighten monetary policy late in the cycle is likely to be resolved with the release of quarterly inflation data this week — and the currency is set to feel the fallout.

Economists ahead of Wednesday’s data forecast that headline consumer prices would rise 3.8% in the second quarter from a year earlier, up from 3.6% in the prior period. Core inflation, which smooths out volatile prices, is expected to hold steady at 4%. That’s higher than the Fed’s most recent forecast of 3.8% and suggests limited progress in reining in prices.

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“If inflation is below four percentage points and they don’t raise rates, that starts to have a significant impact on their anti-inflation credibility,” said Stephen Miller, investment strategist at GSFM. “That could mean longer-dated bond yields in Australia will suffer and certainly underperform the US.”

The Reserve Bank of Australia has raised interest rates by less than its global peers as it seeks to hold on to employment gains while worrying about the ability of debt-laden households to cope. Stubborn inflation suggests the RBA will miss its target of returning price gains to its 2%-3% target late next year, likely requiring another hike — and risks tipping the weak economy into recession.

The price report comes on the heels of better-than-expected job growth and strong retail sales, while business surveys have remained resilient. A partial gauge of prices rose more than expected for a third straight month in May, raising questions about whether policy is “restrictive enough.”

The Reserve Bank of Australia has pledged to be “vigilant” about the risk of rising prices, and the rate-setting board considered raising rates in June before deciding to keep rates at 4.35%. Although the odds are lower than earlier this month, financial markets are still pricing in a one-in-five chance of the RBA raising rates at its August 5-6 meeting.

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“Inflation in Australia remains relatively high compared to its global peers,” said Diana Mussina, deputy chief economist at AMB Ltd. She believes a quarterly result above 1% “will likely lead to the Fed raising interest rates” because it would be further from its inflation target.

Economists expect inflation to rise by 1% compared to the previous three months.

Financial markets and policymakers won’t be the only ones anxiously awaiting the data. Slowing inflation and the end of interest-rate talks could keep the door open for the center-left government to call early elections this year. Accelerating price growth and the threat of further tightening are likely to rule that out.

Inflation in the last quarter was driven by housing rents and housing costs as well as insurance and financial services. In addition, fiscal spending remains strong, especially at the state level, supporting demand and prices.

Australia’s political caution has put it at the back of the global cycle as the Reserve Bank of Australia debates raising interest rates at a time when some other banks have already started easing. The Bank of Japan is an outlier, with Bloomberg Economics forecasting a rate hike on Wednesday.

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Elsewhere, the Bank of Canada cut interest rates in succession, while the European Central Bank also cut rates. China, Australia’s largest trading partner, also lowered borrowing costs.

The Fed is likely to lay the groundwork for a September shift at its meeting this week. A particularly hawkish Fed could warn the Reserve Bank of Australia against raising interest rates.

“With China easing monetary policy and the risk of easing from the Fed and other developed market central banks, the RBA is keenly aware of the need to adjust monetary policy when the pulse turns negative,” said Prashant Nyonah, chief interest rate strategist at TD Securities in Singapore.

“The CPI is unlikely to rescue the slide,” Nyonaha said, pointing to the recent sell-off in the Australian dollar.

The Australian dollar has fallen about 2% against the greenback this month, making it one of the worst performing currencies in major developed markets, as lower commodity prices and worries about China’s economy have hurt risk sentiment. That’s a reversal for the currency, which has been among the best performers in bets on a rate hike by the Reserve Bank of Australia.

—With assistance from Shinjini Data and Ben Westcott.

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