analysis: Another double rate hike coming but the Reserve Bank may soon slam brakes on again

Prepare yourself for another hit.

When the Reserve Bank heavyweights gather around the board table in Martin Place tomorrow, the question will not be about whether to raise rates, but by how much.

The consensus is that we will be whacked with a fourth successive double hike although some forecasters, such as Saul Eslake, believe the RBA this month will begin to moderate the rises, scaling them back to 0.25 percentage point hikes.

Having arrived at the rate hike party unfashionably late, the Reserve Bank is increasingly coming under pressure from outside forces to maintain the momentum, particularly since US Federal Reserve boss Jerome Powell declared his intention just over a week ago to continue the fight against inflation.

Since that speech, already skittish financial markets have done an about face.

Just when they thought the worst may be behind us, they've been forced to re-evaluate their predictions about the level at which interest rates would top out, with much higher forecasts that have sent stocks and bonds tumbling.

Wall Street last week shed around 7 per cent while our market declined around 4 per cent with a couple of days of particularly heavy selling.

Right on cue, our housing market decline gathered speed last month, dropping at the quickest pace in 39 years. It's now spread across the nation with the regions heading south and every capital except Darwin in decline.

Asset markets are on the slide globally and central banks, led the US Fed, don't seem overly concerned.

That shift in attitude is significant. Having spent the past 20 years jumping to the defence of financial and property markets, slashing rates at the slightest hint of trouble, the world's biggest central bank suddenly has decided to play hard ball with a steely resolve to kill inflation first and worry about recessions later.

Whether it is going too hard is too early to tell. But its actions will have repercussions globally, including here.

How high will RBA hikes go? 

Another double hike tomorrow will take the official cash rate to 2.35 per cent. From a standing start at a touch above zero in May, the pace of rate hikes has been incredible, unlike anything we've seen in decades.

If you believe money markets, the RBA will rapidly push towards 4 per cent, although the speed at which money markets shift their forecasts is breathtaking.

The more sensible commentators, including Eslake and the Commonwealth Bank's Gareth Aird, believe we've seen the worst of it, that while there are further rate rises to come, the pace will slow significantly.

There's a simple explanation for their thinking. It takes quite a while for the full effect of interest rate changes to bite. It's what is known as the lagged effect.

While we've seen a drop in housing prices, because banks no longer are prepared to lend the kind of money they previously were, there have been few early signs of any slowdown in household spending.

One reason is that the banks take a while to push through rate changes to their customers. Another is that it takes some time before consumers start backing off on their spending. The tide initially turns gently before receding at a faster pace.

There are other factors too. A large number of new housing market entrants took out fixed rate mortgages, which unwind over the next 18 months so the impact of higher interest rates effectively has been delayed.

The RBA now is at the point where it needs to exercise caution. If it continues to slam mortgage holders and business owners with rapid fire rate hikes, it may find by Christmas that it has overstepped the mark and may need to reverse course.

That would be a disaster. The whole idea behind monetary policy is to keep the economy on an even keel, to add a touch of accelerator when things are slowing down and gently apply the brakes when it appears the economy is overheating.

Slamming on the brakes, as it is doing now, is a dangerous tactic, one that it could easily get wrong. And let's face it, the RBA hasn't had a great track record of late when it comes to picking the cycles.

The currency conundrum

The Aussie dollar has been like a jack in the box of late bouncing around between US72c to under US68c.

The slowdown in China is one factor. Iron ore prices have come off the boil in recent months.

But the biggest influence has been the strength of the greenback. As the Fed has jacked up interest rates, the US dollar has soared. In June, America walloped borrowers with a triple hike sending the cash rate to as high as 2.5 per cent.

The next US hike quite possibly could be another triple whammy, sending rates to as much as 3.25 per cent. Such a move would light a fire under the greenback and see the Aussie dollar sink.

That's something that would be of serious concern to the RBA. A weaker currency is inflationary, because it costs more to import goods. Given the entire focus right now is to kill inflation, the temptation within Martin Place would be to ensure our currency doesn't weaken too much.

There is a danger the RBA may become swept up in the vortex and push rates higher than it should just to support the currency.

Those thinking of an overseas sojourn might not agree but a weak currency isn't all bad.

It makes local industry more competitive and boosts exports which helps keep unemployment lower.

Can we avoid recession and maintain full employment? 

If there is one truly bright spot for the economy right now, it is with employment.

With the jobless rate sitting at just 3.4 per cent and with wages growth way below that of the US, there is a genuine feeling that we may have a once in a lifetime opportunity to get back to the post war days of "full employment".

For half a century, the belief has been that we need a pool of unemployed to keep inflation in check. It's a theory that evolved in the aftermath of the inflation breakout in the 1970s, that we needed around 5 per cent of the working population to be out of a job to ensure a plentiful supply of workers.

So entrenched in economic theory is the practice, it even has its very own acronym. It's called the NAIRU, the Non-Accelerating Inflation Rate of Unemployment.

The theoretical rate has varied over the years and more recently, it has dropped. From 5 per cent, it was lowered into the fours a few years ago and now sits in the threes.

Whether that trend can be maintained is highly uncertain as the intent behind rapid rate hikes is to throttle growth and wind back demand, which then impacts jobs.

The economy already is slowing rapidly. Housing prices are dropping at a rate of knots, particularly across the eastern states, which will lead to what's known as a "negative wealth effect". If everyone feels poorer, they'll spend less.

Building approvals last month dropped almost 18 per cent, while new lending for housing declined almost 8.5 per cent in July.

This is hardly the kind of "steady as she goes" strategy long adhered to by central banks.

Once tomorrow's rate hike is out of the way, RBA boss Philip Lowe will need to tread carefully.

He clings to the belief that a "narrow path" to economic Nirvana still exists, that we can beat inflation and not end up in recession.

But the trail is becoming littered with obstacles.