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Home Loan Interest Rate Rise

Not surprisingly, market pricing around the Reserve Bank's potential action has changed markedly. In late April, before the Budget was released and before the market became aware of the lost momentum in the data, market pricing pointed to a 75% probability of a rate hike by mid 2015 and a near 100% probability of two rate hikes by year's end.

Now markets are pricing in a 50% probability of a rate cut by mid 2015 and a zero probability of a rate hike by end 2015.

Current pricing stands in sharp contrast with Westpac's expectations of home loan rates to firmly on hold over the next 12 months, with two rate hikes in August and November next year. This view is predicated on a number of key observations on the state of the economy.

On housing investment, a distinction needs to be made between marginal momentum and the absolute level of activity. After rapid growth through 2013, annualised dwelling approvals are at a high level relative to history, just below 200k. As this activity comes on line, it will provide critical support to activity and the labour market, most notably in key eastern states.

On the labour market, forward indicators remain more positive than the labour force survey; the implication here is that more robust employment growth is anticipated in coming months. While it will likely not be enough to arrest the slow rise in the unemployment rate until year end, stronger jobs growth will support household incomes and affirm their expectations over the labour market. Coupled with continued house price growth, greater confidence in the labour market should be a positive for household demand through 2014 and into 2015.

This will provide a broadening of the demand base for Australian businesses. Australian firms have remained more sanguine on the outlook following the Budget than consumers; and, as at June, conditions and confidence were both modestly above long-run average levels, according to the NAB Business Survey.