Interest rate and currency consensus breaks wide open

If the best set of monthly employment gains in more than six years is enough to push the Australian dollar hurtling towards US80¢, what will next week’s inflation data do if it comes in on the high side?

That’s the question traders will be asking after a decent rise in full-time jobs in June was enough to encourage them to place bets that the Reserve Bank will be raising interest rates some time in the first half of next year.

Indeed, at this stage a move to 1.75 per cent, up from the current record low level of 1.5 per cent, is considered a 60 per cent chance for February, 2018. The probability increases each month until May, when it is considered a dead-set cert.

It might be just over two weeks since the Reserve Bank met and kept the official cash rate on hold, but already the consensus on interest rates and the Australian dollar has been severely challenged.

Guy Debelle will be asked about the dollar when he makes a speech on Friday.

Daniel Munoz

The chorus from economists and financial markets was remarkably harmonious back then. Rate rises were expected by only a select few and, according to most economists rates, were on hold for quite some time.

The release of the minutes of this month’s meeting and talk that the neutral cash rate is 3.5 per cent have changed all that.

Now, any piece of economic data that is better than expected will be pounced on as proof that rates need to go up.

On cue, the 62,000 rise in full-time jobs in June, announced on Thursday, was enough to send the Australian dollar on its merry way, although traders did seem to get a little nervous at the pace of the rise as it got closer to US80¢.

Maybe they were reminded that not long ago, any labour market number coming out of the Australian Bureau of Statistics was fobbed off as complete rubbish.

Still, in late-afternoon trading the Australian dollar was fetching as much as US79.31¢, while earlier this month it was closer to US76¢ after Philip Lowe, governor of the Reserve Bank, reminded everyone that the whole economic outlook continued to be supported by the low level of interest rates.

He also said the “depreciation of the exchange rate since 2013 has also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment.”

Now, of course, the Australian dollar has got US80¢ as a target and everyone is worried about the official cash rate going to 3.5 per cent.

It looks way too high, but if the real cash rate, taking inflation into account, is meant to be 1 per cent, then take the average inflation rate of 2.5 per cent and it means the official cash rate has to be 3.5 per cent.

But the real cash rate now is just below zero and, unless there is a big spike in wages, probably should stay there.  

Timely reminder

The robust June employment report does serve as a reminder that things can change very quickly and, although there’s still plenty of spare capacity in the labour market, the latest numbers show it doesn’t take long for it to be all used up.

For now, economists will point to the breakdown between a robust labour market and higher wages that in the past has led to higher inflation.

These days it doesn’t – but traders will be willing to bet that it can all change very quickly.

Next week the June-quarter inflation numbers will be released and  expectations centre around a quarterly increase of 0.5 per cent for core inflation, which keeps the annual rate unchanged at 1.8 per cent. 

But watch out if it comes in higher than that.

Higher energy prices might play a role in pushing the consumer price index higher, although they will probably have more of an impact in the September quarter.

In the current environment, any hint of inflationary data is going to lead to more speculation about higher rates.

That will also put upward pressure on the Australian dollar, so expect to hear these words repeated a fair bit by RBA officials over the next week when it comes to the local dollar: an appreciating currency is unhelpful.

It will probably start when deputy governor Guy Debelle speaks on Friday.

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