First step to form a view related to the term structure shift is to forecast the possible change of the RBA cash rate, as it is the foundation of the reconstruction of the whole curve. The RBA has kept the cash rate at 49-year low at 3% since April (Figure 1). The following process of predicting the RBA’s monetary policy consists of our views toward macroeconomic condition, fiscal policy effect, inflationary pressure and finally, our conclusion of monetary policy.

Figure 1: Source: http://www.bloomberg.com/markets/rates/australia.html

Economic Recovery

According to RBA’s Financial Stability Review finalised on 23 September 2009, conditions in the global financial system have improved significantly over the first half year. However, markets remain under a degree of stress, extreme risk aversion has dissipated. The Report also summarised that the Australian financial system has, throughout the crisis period, remained resilient (Ibid). Australia has been the only OECD country which was not in a recession in the financial turmoil.

UBS chief economist Scott Haslem (2009) states in an interview by ABC Television that it will make the RBA feel uncomfortable sitting there with a 50-year low interest rate when the emergency situation is not there any more, and he continued to expect the central bank to raise the cash rate by one percentage point before the end of the March quarter of 2010, with the first hike likely happening at the November meeting.

Fiscal Policy-Stimulus Package Continues

The G20 finance ministers meeting in London on 14 November has urged countries to keep economic support measures in place until recovery in the global economy is secured. And Treasurer Wayne Swan told reporters in the Doorstop Interview on 4^th August 2009 "that the government's $42 billion stimulus package would continue and to reduce stimulus or to pull it back would pull the rug out from underneath economic recovery."

But Federal Opposition Leader Malcolm Turnbull says the Government must realise that continuing with its economic stimulus strategy will force up interest rates. (ABC news).

Inflation – the Key Indicator of Monetary Policy

The all groups CPI rose 0.5% in the June quarter 2009, compared with a rise of 0.1% in the March quarter 2009 (ABS, 2009). The next CPI will be released on October 21. Westpac institutional bank’s chief economist Bill Evans, currently (week beginning 28 September, 2009) forecasts a 0.8% print for the September quarter underlying inflation. This is an annualised 3.5% figure, exceeding RBA’s forecast of 3.25%.

Governor Glenn Stevens (2009) said the inflation targeting framework the Reserve Bank has been following for a decade and a half will guide adjustments to interest rates. These will be timely and ahead of a build-up of imbalances that would occur if interest rates were kept low for too long.

Monetary Policy

Since August, speculation has mounted that the RBA will soon raise rates. Debt futures markets are now indicating there is a 50 per cent change of a 25 basis point interest rate rise in November (AAP, 2009).

In an Opening Statement to Senate Economics References Committee, Governor Mr Glenn Stevens (2009) gave signal that interest rates were set to rise from current historical lows as the economic recovery progressed. Mr Stevens said any interest rate moves would be "timely and ahead of a build-up of imbalances that would occur if interest rates were kept too low for too long".

In a research note, JP Morgan chief economist Stephen Walters said he expected the RBA to start lifting the cash rate at next month's board meeting (AAP, 2009).

Monetary Policy Forecast

To summarise, with the recoveries of the global and Australian economies, and the pressure of retaining the government spending, potential inflation risk is concerned and followed closely by the RBA inflation targeting framework. Against forecasts from majority economists of maintaining the current level, we believe that the RBA is likely to start interest rates hike starting from the next Board Meeting on 6^th Oct. In order not to jeopardise the fragile success of previous efforts, the possible increase will be a moderate 25 base points, upon the current “emergency” level.

During our investment term of 28^th September to 9^th October 2009, the next Reserve Bank Board Meeting (6^th October) outcome is due at 2:30 pm (AEDT). This is the time when the outcome is published.