A few items of interest

NB: I spent a great deal of time putting together this post, in original form, only to have Blogger eat it. I hope not too much of the original enthusiasm for the topic has passed.

The Goldilocks Australian economy and market has been coasting along without an interest rate care in the world for months on end now. And, until the last day or so, it appeared there was just no sign of any rate increases anywhere on the horizon, nothwithstanding CenBanks around the world cranking up theirs.

Suddenly the possibility of such an event occuring here in the Land of Oz has hit the forex screens and the bond screens if not the equity screens. Corinne Lim, writing in the AFR, tries to put her finger on the whyfores and wherefores of the thing:

Traders priced in a one-in-four chance that rates would rise a quarter of a percentage point to 5.75per cent by September. A week ago, they didn't see any chance of an increase.

The mood spilled into the Australian dollar market, juicing up a recovery in the currency that was already under way, thanks to renewed buying from real money investors in the US and Europe. The $A popped above US72¢ yesterday, its highest in more than two weeks.

Now, the RBA left rates unchanged yesterday at 5.5per cent, as widely expected, for the 13th month in a row - so why were traders spurred into putting down bets on a rate rise?

The chattering masses had toyed with the idea since last Friday, when a trio of unexpectedly strong February data - credit, building approvals and retail spending - highlighted a sudden pick-up in household demand.

Consumers had perked up, thanks to a vigorous jobs market, the wealth-enhancing effects of a booming sharemarket, steady rates for a protracted period and a recent ascent in home prices.

The development would certainly heighten the RBA's vigilance with regard to domestic demand and inflation. The central bank was already predisposed to raising rates again, having said so since November.

"Policy would need to respond in the event that demand or inflation pressures prove stronger than expected," the RBA said in February.

Some of yesterday's flap in futures - which started on Tuesday night during offshore trading hours - was attributed to a change in tune from at least one economist on the outlook for monetary policy.

"After a long period of inactivity, the tide looks to be turning on the local interest-rate front," Macquarie Bank's interest rate strategist Rory Robertson said in a note.

"Indeed, if the data were to fall the wrong (right?) way from here, the RBA's next rate hike could be as little as a month away."

Robertson had previously professed the central bank's inclination to lift rates again was "weak" and 5.5per cent was likely to last "well into 2006".

The stockmarket, by the way, didn't seem fazed by rates talk.

Matt Wade, Economics Writer for the SMH, adds a bit more to the picture:

Interest rates are on the rise globally. Central banks in Japan, the US and Europe are expected to soon increase rates further.

Inflation is already already at the top of the RBA's target band of 2 to 3 per cent and the bank's most recent monetary policy statement said it "would need to respond in the event that demand or inflation pressures prove stronger than currently expected".

In February RBA governor Ian Macfarlane said the next interest rate move was more likely to be up than down.

Mr Koukoulas is tipping a rate increase in June or July. But a large number of economists expect the RBA to wait until the December quarter or next year.

Friday's monthly Reuters survey of Australian economists found only five of the 17 economists polled expected an interest rate rise this year.

And the AFR editorialises,

"Reasons for the economy's robustness are not hard to find. The global economy is going from strength to strength and rising global interest rates have taken the edge off the Australian dollar, making it less of a hindrance to exporters.

Booming export commodity prices are fuelling growth - especially in the resource-rich states - corporate profits and wealth generally. This is boosting the federal government's surplus and the scope for more tax cuts. At the same time, credit is loose and ever more widely available.

Against this backdrop, a further tap on the interest rate brake pedal might be advisable - even if, due to strong global competition, it turns out that overall underlying inflation remains benign this year."

Meanwhile, back in the USofA, Federal Reserve Board Member and New York Federal Reserve President Timothy Geithner was trying to warn against complacency, according to Victoria Thieberger writing for Reuters:

Economic stability should not make investors complacent to the possibility of future financial turbulence, New York Federal Reserve President Timothy Geithner said on Wednesday.

Speaking before the New York Bankers Association, Geithner laid out a relatively benign outlook for the economy, but peppered it with warnings about the continued strength of the financial system.

Geithner argued expansion in global economic activity had become more broad-based, yet also reiterated his concern that the growth of investment vehicles like hedge funds had the potential to magnify any eventual crisis.

"We are in the midst of a period of perceived strength in economic fundamentals in the United States and many countries around the world," he said in prepared remarks, adding that inflation had stayed contained despite high energy prices.

But this optimism came with big caveats.

"The more critical role played by hedge funds and other non-bank financial institutions in credit and other markets has the potential to magnify the impact of distress in those institutions on market dynamics and liquidity if counterparty risks are not managed appropriately," he warned.

Geithner said that greater concentration in some markets had the potential for making the financial system more vulnerable in case of a bank failure.

The trouble with periods of relative stability, argued Geithner, is that they made it more difficult for banks to appropriately assess risk.

Risk measures in financial markets have fallen sharply in recent years, with spreads on everything from corporate bonds to emerging markets hovering near their tightest levels ever.

Part of this reduction in perceived risk had to do with improvement in global economic fundamentals. But analysts say much of it was also due to ample liquidity during a prolonged period of rock-bottom interest rates in the industrialized world.

Some fear the crunch from rising borrowing costs in the United States and abroad could unsettle the markets.

Interestingly, this is pretty much coming from the same song sheet from which the Australian Reserve Board has been singing.