THE Reserve Bank's six-year tightening cycle may have hit a peak amid fresh signs that recent interest rate rises are curbing domestic demand in the Australian economy.
The central bank signalled for the first time that evidence was emerging that domestic demand could finally be slowing after 16 years of unprecedented economic expansion and following what it described as a "substantial" tightening of credit conditions since mid-2007.
"There is tentative evidence that some moderation in household demand is beginning to occur, with business and consumer sentiment softer recently and household credit demand slowing somewhat," Reserve Bank governor Glenn Stevens said.
The less hawkish comments from Mr Stevens followed anecdotal claims that consumer spending has slowed and yesterday's news that retail sales in January were flat and much weaker than expected.
The decision to raise the official cash rate by 25 basis points to 7.25 per cent followed data showing that Australia's current account deficit had ballooned to an all-time record of $19.3 billion, or 7 per cent of gross domestic product, in the December quarter.
This included figures showing that imports are satisfying more of the excess domestic spending, leading market economists to clip their forecasts for the economy's GDP numbers to be released today.
Signs of less frantic economic growth and the less hawkish tone of Mr Stevens' statement prompted the market to rethink expectations that rates were set to rise again in May.
The pricing had been as strong as 60 per cent that the RBA would move before the Rudd Government's first budget, but that figure has been sharply pared back.
Pricing in the interbank futures market suggests that the central bank could be forced to cut rates in 2009, as the economy slows.
The interest rate rise was the 12th consecutive increase since the cycle began in 2002 and will prompt the retail banks to lift variable mortgage rates above 9 per cent — the highest in 12 years.
The RBA has flagged it wants domestic demand growth to slow, with real non-farm GDP expansion needing to be reined in to 2.75 per cent this year.
While acknowledging that financial market sentiment remained fragile and the global economy was forecast to weaken this year, Mr Stevens highlighted that the current surge in commodity prices would stimulate the Australian economy.
However, Mr Stevens said the RBA would evaluate the prospects of growth and inflation after the "substantial" tightening in credit conditions since the middle of last year.
Economists interpreted the bank's tone as less hawkish than previously, which tempered expectations rates could be tightened once again.
The financial markets reacted as the bond markets rallied and drove down yields across the curve.
The less hawkish rates outlook, coupled with the gloomy current account deficit, led to the dollar being sold down throughout the day from US93.85c to 93.18c.
The Commonwealth Bank downgraded its recommendation on the $A slightly. And the market's consensus for GDP growth figures to be released today was marked down noticeably on the back on the current account deficit, which, in relative terms, is significantly larger than the "banana republic" deficits of the mid-1980s.
UBS economists said today's GDP figures would show a weaker than previously expected growth of 0.3 per cent in the December quarter, clipping the economy's annual growth from 4.3 per cent to 3.3 per cent.
