RBA Preview: Inflation Pressures the RBA to Tighten Further

We expect the RBA to increase its policy rate by 25 bps to 4% on February 2, the central bank's first meeting in 2010. This will be the 4th rate hike by the RBA after it had taken the cash rate to 3% in April 2009. Rise in domestic price pressure and surge in housing prices are major forces triggering the RBA to tighten further.

In 4Q09, Australia's headline CPI rose +0.5% and +2.1% on quarterly and yearly basis respectively. Underlying inflation also remained well-above RBA's target of 2-3% at 3.4% on annual basis. The most significant price increases came from fruit, and domestic holiday travel and accommodation which were partly offset by decline in audio, visual and computing equipment, and pharmaceuticals. The price index for 'non-tradable good' rose +2.6% yoy in 4Q09 from +2.3% a quarter ago, indicating strong domestic price pressure.

Domestic demand grew stronger as unemployment rate declined to 5.5% with the number of payrolls rising for a 4th straight month in December. Consumer confidence also improved consistently.

At the December meeting, the RBA said that credit for housing is expanding at a solid pace. We believe this has been driven by rise in house prices. Although the central bank also noted decline in business credit, it's not likely due to credit tightening. Rather, a wide network of accessing to liquidity in the market through equity capital and debt markets were the reasons for a drop in bank lending to businesses.

Housing market in Australia has improved considerably since the second half of last year as boosted by low interest rate and government incentives for first-time homebuyers. House prices surged +5.2% qoq in 4Q09. This was the biggest rise in 6 years.

Strength in AUD has in past months helped limit inflation pressure. While many retailers are not factoring in 'lower' prices of import goods, correction in Aussie also damps effect of currency on inflation.