Big rate rise on the cards as market tumbles

Australian markets have fallen sharply this morning as fears mount about a looming US recession.

At 12.34am the S&P/ASX200 was down 3.1% to 5398.50 after dropping more than 100 points in the first five minutes of trading, effectively wiping around $40 billion from the market’s value.

Economic warnings by US Federal Reserve Govenor Ben Bernanke late last week sent US markets into a spin, with the benchmark Dow Jones index falling 2.51% to 12,266.39, and has in turn spooked Australian markets this morning.

But while the markets focus on problems in the US, a clutch of Australian economic data released today paints a picture of an economy just about bursting at the seams.

The TD Securities/Melbourne Institute inflation gauge has risen by 0.3% in February to its highest point in six years thanks to soaring rent and food prices.

That means inflation has increased by 4% in the year to February, a figure that will alarm Reserve Bank of Australia economists dedicated to keeping inflation below 3%.

Key business indicators from the December quarter last year also point to strong conditions, with company gross profits up a strong 3.9% on the previous quarter and wages growing at or slightly faster than inflation on 0.9%.

And the manufacturing sector managed to reverse a significant decline in January to post a positive result in February, according to the Australian Industry Group-PricewaterhouseCoopers Australian Performance of Manufacturing Index, which picked up 2.2 points to rise above the 50 point line separating expansion from contraction.

All that means when the RBA board meets tomorrow the key question likely to be debated will not be if interest rates should be lifted, but by how much. The market has locked in a 0.25% rise as a near certainty, but 0.5% is certainly not impossible given today’s figures.

And apart from hitting mortgages where it hurts, a 0.5% rise would likely put a rocket under an Australian dollar already performing strongly – at 12.34pm it is trading at US93.05 cents, but traders predict it could easily go as high as US96 cents in the weeks ahead.