Daily Commentary BY THE CURVE TEAM –

Inflationary Pressures and Fed Meeting Could Impact RBA

16th of February, 2018

Further evidence of inflationary pressures building in the US overnight set up an interesting FOMC meeting next week. It comes at a time when geopolitical tensions are rising, casting a cloud of uncertainty over the broader global outlook.

Trade price data in the US suggest there are further price pressures building after PPI the night before also came in ahead of expectations. The fall in the USD is pushing up import prices, which were up 0.4% February and have been steadily rising for the past seven months. If import price pressure is sustained, we could see the annual rate lift well above the current 3.5% over the coming months.

The trade price data adds to the PPI uplift from the previous night. While the price pressures in the preferred measures, CPI and more importantly PCE, aren’t as evident as yet, data from the past two nights suggest that price pressures are slowly building.

It adds a little extra spice to the FOMC next week when combined with sustained strength in employment data, even if wages aren’t bursting higher. The market is almost unanimously expecting the FOMC to hike when they meet next week. That means the focus will be squarely on the dot plot and whether or not it suggest a further 2 or 3 hikes for the remainder of the year after next week’s hike.

This is an important development that the RBA will be watching closely. A hike from the FOMC will take the Fed Funds Rate above the RBA’s cash rate. It will be the first time that our cash rate has inverted to the US since the early 2000s. This could have a number of ramifications for Australia.

One area where it could impact us is on the currency and the overall setting of monetary policy. While the Australian economy is in many ways different compared to the last time the cash rates inverted, we could still see the currency come under pressure.

A small fall initially would likely be welcomed by the RBA. However if that fall were to gather pace they it could draw a reaction. The inversion could well eclipse the levels we saw back then based on the current outlook for both central banks. For that reason, the RBA will be paying close attention to what the FOMC does and says next week.

David Flanagan

Director - Interest Rate Markets