Markets expect RBA to hold fire

THE Reserve Bank will place greater emphasis on the suffocating impact the high Australian dollar is having on the economy when it meets for the first time this year to consider interest rate cuts.

However, the expectations are that the central bank will hold off until next month.

Even with softer economic data adding pressure on the RBA to lower rates, forecasts of a cut have fallen to their lowest level in months.

The financial markets' pricing of an interest rate cut this month stood at 22 per cent, Credit Suisse data showed. Markets were pricing in a near certain cut in the cash rate by 25 basis points for the year, and a 50 per cent chance of a second rate cut.

The release on Friday of weaker-than-expected Chinese official purchasing managers' index (PMI) data pushed the dollar to a low of US103.8¢ against its US counterpart, but some economists expect the dollar to remain strong between US104¢ to US105¢ for the year.

This, they say, could force the RBA to continue its easing cycle, although from next month rather than now.

"We think it is going to be like a war of attrition, with the currency staying high and the RBA being very careful," NAB's chief economist for markets, Rob Henderson, said.

"We don't think they are going to rush in and do two rate cuts in a row. But we think the evidence will keep accumulating, with the economy still soft, unemployment rising and the inflation outlook continuing to be better."

NAB expects the Reserve Bank to lower the cash rate to 2.25 per cent by the end of the year, with an average of about one cut per quarter. The cash rate now stands at 3 per cent.

Justin Fabo, the head of Australian economics at ANZ, which has tipped rates to drop to 2 per cent by the year's end, said higher unemployment figures and subdued corporate capital expenditure plans for 2013-14 could prompt the RBA to act next month.

"We think it's less likely now that we'll get the 100 basis points of cuts that we've got pencilled over the rest of the year," Mr Fabo said, adding that ANZ was not yet revising its forecast.

Mr Henderson said the Australian dollar's strength would also continue to dampen investment outside mining, stifling growth in sectors such as tourism and agriculture.

Michael Workman, a senior economist at Commonwealth Bank, which along with HSBC expects rates to remain at 3 per cent for the year, said he believed there had been a significant shift in the risks - especially offshore - to the economy.

"The US and the European data is implying an improvement in their economies ... while it's quite obvious that China's growth bottomed out around about the third quarter last year and is also improving," Mr Workman said.

The HSBC chief economist, Paul Bloxham, said he believed the "soft patch" in the economy had passed and growth would pick up this year, supported by China's recovery and low interest rates.

"The weekly consumer sentiment measure has risen sharply and daily housing price data showed a pick-up in January. Business sentiment bounced back in December and new home sales have risen solidly. Equity prices have rallied recently, hitting a 20-month high," Mr Bloxham said in a research note.

He added that the federal election in September could also result in a further rise in government spending.