It is going to be a busy night in Australia with the Reserve Bank gearing up for its next monetary policy announcement. The last time the RBA met was on May 3 and at the time, the central bank left rates unchanged even though they expected inflation to rise because they felt the strong Aussie would help to hold prices down. However given the trend of inflation and the central bank’s rosy outlook for growth, “rates will need to be increased at some point” according to the RBA. The only question is, how quickly will the RBA act?

Based upon how the economy has performed since the last monetary policy announcement, there should be no urgency within the RBA to raise interest rates. Service and manufacturing activity slowed materially in May while inflation expectations and consumer confidence declined. GDP numbers for the first quarter showed growth contracting by 1.2 percent, which was the steepest decline in 20 years. The table below shows how the Australian economy has deteriorated since the last RBA meeting and yet many people expect the RBA to be hawkish with a minority even calling for a 25bp rate hike this evening.

Why in the world would economists be so optimistic given the deterioration in the Australian economy - the reason is because continued demand for Australian products has helped to boost the terms of trade while investment demand remains solid. The sharp pull back in the first quarter only means a stronger rebound in the second according to market watchers. Although recent comments from the RBA suggests that the central bank is optimistic about the outlook for the local economy, we would not rule out the possibility of more cautious comments given the disappointments in economic data and the strength of the Aussie.''

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.