Will the RBA Raise Rates on Melbourne Cup Day?

If you believe the financial markets, there is a 90% probability that the Reserve Bank of Australia will increase out the cash rate from 6.5 per cent to 6.75 per cent.

US Figures Nov 07But unlike other Board Meetings, there has been a gap of about a fortnight between the releases of the CPI figures and when it actually does meet on 8 November. And much can happen over that period.

The US housing figures and finance crisis have deteriorated. And yesterday, the Federal Reserve further reduced the US cash rate down to 4.5 per cent — to help restore some confidence.

In deciding whether the RBA does need to raise our cash rate, you ought consider several key issues:

* The recent CPI figure actually refers to the past;
* Interest rates are a rather blunt instrument, when used to control the economy;
* US events will dampen overall global confidence; and
* Our homeowners are already stretched to breaking point on their mortgage payments.

However, through the RBA’s insistence that it “won’t be swayed by an election” … it has effectively backed itself into a corner. Therefore, it is probably looking for some concrete external event, to help justify NOT increasing the cash rate on Cup Day.

Part of the RBA’s rationale for increasing interest rates has been to maintain a significant spread between the US interest rate and the Australian rate.

Principally, it does that to keep our dollar strong and help contain inflation — by keeping import prices lower.

As the US raised its rates, the RBA tended to follow suit. And, over time, a spread of about 0.75 to 1.0 per cent (between US and Australian rates) seems to have been the RBA’s target.

However, with the current troubles in the US, the Federal Reserve has been giving the RBA a great helping hand.

p=. Interest rate spread

As you can see from this table, the spread in November 2006 was 0.75 per cent; and our dollar was at 77.4 cents. Today, the spread is running at 2 per cent; and our dollar is now sitting at 93.1 cents.

Therefore, the RBA’s principal motive for raising rates no longer has any real substance; and instead, doing so could cause considerable hardship to our homeowners.

As such, the only reason the RBA could have for proceeding with a rate rise next week … is to save face with the public and the politicians.

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