Prepare for RBA rate hikes

WAYNE Swan’s promised tough budget on Tuesday won’t be enough to stop the RBA lifting interest rates in the next few months.

WARNING, warning. Danger, danger.

Wayne Swan’s promised tough budget on Tuesday night won’t be enough to stop the Reserve Bank of Australia lifting interest rates in the next few months.

July or August looks like the best bet for the RBA to raise its 4.75 per cent cash rate.

The RBA has just made this clear in its quarterly monetary policy report by forecasting underlying inflation will pop above its 2-3 per cent target, even after the flood-affected spike in food prices passes through the system.

By the second half of 2012, it forecasts that underlying inflation will be running at the 3 per cent top of its target. By late 2013, it forecasts that underlying inflation will accelerate to 3.25 per cent as the mining boom, wage and price pressure intensify.

The key point is that these inflation forecasts are technically based on current market pricing of the expected RBA interest rate policy.

This pricing assumes a 25-basis-point increase in the cash rate to 5 per cent by early 2012 and a 5.25 per cent rate by mid 2013.

The RBA is now saying that this market interest-rate expectation is too dovish because it doesn’t keep its inflation forecasts within target.

That breaks a basic rule of central bank inflation targeting.

So the RBA is telling the market that it will have to lift interest rates more aggressively to keep inflation in check.

The May board meeting shifted its tone by warning it would look closely at wage price developments.