Australian rate-tightening cycle will be modest

The Reserve Bank of Australia (RBA) raised its cash rate to 3.25% today, sooner than most had expected. Markets are now pricing in further rate rises back up to a “neutral” level of 5.0-5.5% by late 2010. We are not so convinced. Super-loose policy rates are no longer needed but we expect global outlook uncertainties to rise next year and that Australia’s GDP upswing will disappoint. The RBA we forecast will likely end up lifting rates to 4.0-4.5% by mid-2010 before then going on prolonged hold.