Interest rates tipped to remain on hold

Entrepreneurs and mortgage holders can breathe a sigh of relief – economists expect the Reserve Bank of Australia board will take a breather when it meets tomorrow and leave the official interest rate on hold at 4.5%.

There are growing signs that consecutive rate rises in March, April and May have had an impact on the economy, with a sharp fall in consumer sentiment reported by Westpac last week and signs of patchy conditions in the retail, property and transport sectors still clear.

On top of this, the turmoil on global financial markets stemming from the debt crisis in meltdown have weighed heavily on Australian investors, with the Australian sharemarket down 4.6% since the bank last met on May 5.

Westpac chief economist Bill Evans said earlier this month he expected the RBA would remain on hold until it has a chance to see the latest GDP growth data (out later this week) and the latest inflation data for the June quarter, which is not released until July 28.

However, he argues, “global market turmoil has effectively ensured that the Board will hold steady in June” and expects the RBA will keep its finger off the rates trigger until August.

Bond markets are also backing no change at tomorrow’s rates meeting and are in fact pricing in an 80% chance of a rate cut by September, most likely as the RBA is forced to react to the turmoil in Europe and perhaps even a slowdown in China’s economy.

With this in mind, commentators will be watching Governor Glenn Stevens’ statement accompanying tomorrow’s rates decision for anything that validates the market’s view of a cut.

However, economists are warning borrowers not to hold their breath.

“The board will most likely emphasise the need to closely watch the developments in financial markets and may even note that, with rates now around average levels, the Bank has sufficient flexibility to respond should the situation deteriorate significantly,” ANZ chief economist Warren Hogan wrote in a note to clients.

“But such ‘reassurance’ would also probably be accompanied by the Board reiterating the potentially inflationary consequences of sustained commodity booms. Such a message would imply that rates are firmly on hold for now.”

Indeed, Hogan and Evans remain concerned about the prospect of inflation, driven particularly by rising house prices, utilities costs and wages.

If the CPI data released in July suggests inflation is on the rise, the RBA will have little choice but to act.