Rates on hold but inflation outlook uncertain

The Reserve Bank chose to sit tight and leave rates unchanged for the third consecutive month when it met on Tuesday this week. The cash rate, which is at a 12 year high, will remain at 7.25 per cent.

According to a statement released by RBA Governor, Glenn Stevens, higher interest rates and tougher credit standards for some borrowers have caused a substantial tightening in financial conditions since the middle of 2007.

"The evidence is that this is helping to produce a moderation in demand. While labour market conditions to date have remained strong, indicators of household spending have recorded subdued outcomes over recent months, and credit expansion to both households and businesses has weakened significantly."

While the RBA’s inflation targeting policy seems to be working, Stevens has urged caution.

"The rise in Australia’s terms of trade that is currently occurring will work in the opposite direction. It will add substantially to national income and ability to spend, even with the slowing in global growth to below-trend pace that the Bank has been assuming."

This means that the RBA’s battle to fight inflation is by no means over. Stronger than expected economic data in the first quarter of this year suggests a surprising amount of resilience in the economy. Australian real gross domestic product rose by a seasonally adjusted 0.6 per cent in the March quarter which was much stronger that the market’s forecasts for a rise of 0.3 per cent.

The RBA’s view is that growth in the Australian economy will moderate this year with inflation set to remain relatively high. Rates will stay unchanged provided that demand continues to slow and there are no second round flow-on effects to wages and price setting. Expect the RBA to act swiftly and hike up rates another notch if the economy refuses to cool off fast enough.

Infochoice.com.au