This note looks at the outlook for the Reserve Bank of Australia’s cash rate.

The key points are as follows:

– The Reserve Bank of Australia is continuing to warn of further interest rate increases as interest rates are returned to ‘more normal levels’. This is evident in the minutes from the April Board meeting which refer to the latest rate hike as just another step in the process of returning interest rates to more normal levels.

– Although wider bank lending spreads have reduced the normal level for the official cash rate, probably to around 4.75%, strong immigration levels and structurally higher commodity prices are likely pushing it back up to around 5.5%.

– It’s likely the cash rate will rise above this level in 2011-12. However, the heightened interest rate sensitivity of the household sector, as a result of high debt levels, will likely see the cash rate top out at around 6%, or just above, in 2012.

– It’s a close call as to whether the next move will be in May or June, and this partly depends on next week’s inflation data. Nevertheless, we are allowing for another 0.25% cash rate hike in either May or June and the cash rate rising to 5% by year end, before moving up to a peak of around 6%, or just above, in 2012.

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