Friday’s weaker-than-expected US GDP figure has firmed forecasts that the US Federal Reserve will not hike interest rates at its May meeting on Thursday morning.
This eases some of the pressure on the Reserve Bank of Australia, which also meets this week. Both futures traders and market economists think the RBA will keep rates on hold, with rate rises not expected until early next year.
The RBA is due to meet on Tuesday for its cash rate decision. Photo: Louie Douvis
The persistent weakness of Australia’s consumer economy, exemplified by weak inflation rates, has made it difficult for the RBA to raise rates in the face of a housing boom. But the different state of the US economy, with the Federal Reserve tightening as the RBA stays on hold, has narrowed the yield differential between US and Australian 10-year government bonds to its lowest level in 15 years.
Australia has historically relied on an interest rate premium to the United States to attract foreign capital into the country – the narrowing yield differential has led some observers to believe the RBA could be forced to raise interest rates for this reason regardless of domestic economic concerns.
But the Federal Reserve likely staying on hold this month gives some relief on this front.
Expectations were US GDP would grow by 1.2 per cent in the first quarter, according to a Reuters poll of economists. Instead, the US posted growth of 0.7 per cent, its weakest pace in three years. Household consumption growth disappointed. US analysts partly attribute this to warm weather dragging down heating bills as well as declining auto sales.
In the wake of the figures, futures markets suggest a 13 per cent chance the Fed will hike this week. A clear majority of traders – 70 per cent – expect a hike in June.
“The US consumer spending is the most sensitive part of the US economy,” said ThinkMarkets’ chief market analyst Naeem Aslam. “The Fed is not going to be hawkish when they see that the consumers are not digging deep into their pockets.”
As for the RBA, last week’s inflation figures showed inflation in the past year has risen to 2.1 per cent – within the RBA’s 2-3 per cent target range.
This, as well as economic growth, will comprise the RBA’s agenda on Tuesday, said Societe Generale’s chief Asia-Pacific economist Klaus Baader.
“The May meeting is one of the quarterly meetings when the RBA staff present the new forecasts to the board,” he said. “So the discussion is likely to focus on the outlook for growth, the labour market and inflation, and less on financial stability concerns related to the housing market and household indebtedness.
“It’s not that these concerns have gone away, but the measures announced by Australian Prudential Regulation Authority on 31 March were debated a month ago, and it will take several months until any judgment can be made on their effectiveness.”
Citi economist Paul Brennan said the inflation figures were within RBA forecasts, so are unlikely to cause much change to the next lot of quarterly forecasts to be released on Friday. “The domestic economy is still growing below trend with a fair degree of spare capacity,” he said. “We continue to see no change in monetary policy this year.”
Markets are unlikely to react strongly to an RBA hold, as this is already entirely priced in. May futures contracts were last week pricing in no possibility at all that the RBA would change rates at this meeting. Longer-term futures show small possibilities of rate cuts – between 8 and 12 per cent – at the June to October meetings. Futures contracts do not begin pricing in rate hikes at all until February next year.