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RBA meeting preview: why interest rate may go up this week and when will inflation peak?

RBA is expected to kick off a cycle of seven hikes for the next eight months to push the official rate to 2.5%, a level that we haven’t seen since 2014. However, inflation may peak earlier than expected for three reasons.

Why RBA may increase rates in this meeting?

Based on April’s meeting minutes, the RBA has suggested that a further increase in inflation is expected, while 'the evidence that inflation is sustainably within the 2-3% target range' is the prerequisite for an interest rate rise. This message has led to economists forecasting the interest rate hike will arrive in June.

However, the decade-high consumer price index that came out last week at 5.1%, has accelerated the schedule and turned to support the view to bring the rate rise forward. At the moment, ANZ, NAB, and Westpac have predicted a 0.15% raise at the start of May, while the Commonwealth Bank forecasts a 15bps for June.

How high can the interest rate be?

Facing the 'hotter-than-expected' inflation data, the market seemingly has come to terms with the prospect of a 'higher and faster' rate hike cycle toward the end of 2022. Currently, the cash rate future is pointing to a series of seven hikes for the upcoming eight months - pushing the official rate in Australia to be on top of 2.5%, a level that not seen since 2014.

When inflation may peak?

Given that inflation is a crucial factor in determining how far the interest rate hike cycle can go, the question is: how high can the inflation rate be? When will it peak?

Indeed, no one can predict the future but it’s worthwhile to start with an in-depth look into the underlying elements that drive the inflation we are facing. Based on the recent consumer price index, the biggest driver comes from housing and transport.

For the housing segment, new dwelling purchases by owner-occupiers rose 5.7%, the largest rise since the September 2000 quarter, robust demand for housing construction enabled builders to pass through increases in costs for both materials and labour.

The double digital increase in 'transport' is steaming from a sharp spike in the oil price (11.0% rise) caused by the Russian invasion of Ukraine. Fuel prices reached record levels in the March quarter.

According to the RBA, the 'Inflation had picked up and a further increase was expected', but the reality is that inflation may peak earlier than expected.

The March quarter’s Oil price rise is not sustainable

The price of oil jumped up over 50% during the first quarter of the year and once reached $130 at the March peak. The price is now moving back to the level near $100 but the prospect of a European Union ban on crude imports from Russia may push the price up to some extent. However, the lockdown in China, the largest oil consumer country, is showing little sign of easing and as such, the shrinking demand for energy is unlikely to see the oil price back to its peak in the near term.

House prices cool down

The logic behind the move to lift the interest rate is to increase pressure for repayments, leaving debt-riddled Australians with less free cash. As a result, it will make people think twice before borrowing or spending money - in turn, reduceing the demand for goods and services will limit a price rise.

The RBA has predicted that a 2% rise in rates would cut an estimated 15% off housing prices and the housing market in Australia’s capital city have already responded to the upcoming risks. Clearance rates have begun to level off and dropped below 70%. In February, both Sydney and Melbourne’s clearance rate was nearly 80%.

History data shows RBA’s advantage today

The history data shows that the inflation rate was responding to the rate change effectively. Often, the rate and inflation will peak at around the same period, for example, in 2001 and 2009. Even though the inflation rate today is much higher than the what we have experienced in the past decade, the interest rate today, near zero, is undoubtedly providing a advantage to the central bank in that there is more room for the rate to move.

How could this meeting impact the AUD/USD?

The AUD/USD has been sliding throughout April. Last weekend, China's PMI (purchasing managers indices) fell deeper into contraction in April, in turn dragging the pair its lowest level in three months. While tomorrow’s RBA meeting could lift the Australian currency if a rate hike is confirmed, the next day’s Fed meeting may pull the pair to another direction.

From a technical point of view, January 29th, the bottom of the year was at 0.6992 and will be viewed as the major support level. If the commodity currency is seeking higher, the ceiling of the descending moving tunnel will be the imminent challenge at around 0.7080.

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