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Fears of Australia-U.S rates gap overblown

SYDNEY: Concerns over a widening interest rate gap between Australia and the US that have crimped the local dollar in recent weeks have been overdone, analysts said on Wednesday.

After the US Federal Reserve raised official rates by a quarter-percentage point overnight to 6.0 percent and signalled more to come, analysts said the Reserve Bank of Australia will not be far behind in its next tightening. US rates now stand half a percentage point above those in Australia, as was the case at the start of the year.

"People seem to have forgotten that more often than not Australian rates have been under the US for the past two-and-a-half years," said HSBC chief economist John Edwards.

Hovering around 61 US cents, the Australian dollar proved resilient to news of the Fed rate hike as the market's worst fears of a 50 basis point tightening proved unfounded and speculation turned to the timing of the next rate rise by the Reserve Bank.

The RBA meets twice more before the next US Federal Open Market Committee meeting in mid-May, and is expected to raise rates by at least another 25 basis points from 5.5 percent.

RBA SET FOR MAY

Most economists believe the RBA, whose board meets to discuss rates policy on the first Tuesday of each month, will move in May.

"Had the Australian dollar reacted very unfavourably this morning then April might have been a better chance, but under these circumstances the RBA can stick to its preferred timetable which I suspect would be May," Edwards said.

That will follow the next inflation and wage reports at the end of April, plus another round of monthly activity figures that will clarify whether the recent spate of soft economic releases was indeed just an aberration, as the RBA has argued.

Only one major release, the retail trade report for February, is due before the April board meeting of the RBA.

And the March quarter inflation figures are likely to show a sharp spike in the annual rate to close to three percent, fuelled by the recent rise in oil prices and a low quarterly figure dropping out of the calculations. That will give the RBA ample justification for another tightening.

Inflation has been below the bottom of the central bank's 2-3 percent target band for three years.

"Despite the firm expectation that the Fed will go again at the next meeting on May 16, the plus for the Aussie is the realisation that the RBA will meet twice before this," said Macquarie Bank currency strategist Joanne Masters.

Most economists expect another one or two rate rises to take official rates to 6.0 percent by mid-year to head off inflation pressures. That will likely keep the gap to the US stable.

"We're saying that if they go in April they'll do 25 points, but if they wait then it will be 50 in May and that appears to be a more preferable date," said Commonwealth Bank currency strategist Michael Workman, noting the bank's semi-annual statement on monetary policy is due out shortly after the May board meeting and will give a platform to justify a hike.

Workman also noted that the differential between official rates with the US has been less important for the dollar in recent times than three-month market rates.

The Australian dollar has been the victim of negative market sentiment in recent weeks, spurred by weak economic releases, that pushed the currency to 17-month lows just above 60 cents and confounded earlier bullish forecasts. Some economists late last year forecast that the local currency would be heading towards 70 cents by now.

The dollar was steady on the day at $0.6087/92.

The RBA will want to avoid the appearance of raising rates to defend a soft currency.

"I think the RBA would look for the greatest possible disconnect between the tightening and the currency, and the disconnect is provided by those CPI and wages numbers at the end of April," Edwards said. -Reuters