As was universally anticipated the RBA increased the cash rate by another 25bps at today’s policy meeting. This puts the cash rate at 3.6%, a high since May 2012, and makes it 10 straight meetings the RBA has lifted interest rates in its battle against inflation. After kicking things off in May 2022, the RBA has now increased the cash rate by a cumulative 350bps making this the fastest and most abrupt tightening cycle since at least the 1980s.
The RBA doesn’t look to be finished just yet. It retains a hiking bias, noting it “expects that further tightening of monetary policy will be needed to ensure that inflation returns to target”, however it also looks to be taking things off autopilot and will take a more measured and staggered data-dependent approach from here. Importantly, unlike in February when the RBA stated that it anticipated “further” rate hikes over “the months ahead”, the bank now points out that “in assessing when and how much further interest rates need to increase” trends in household spending, the labour market and inflation will be important inputs.
With policy settings now in ‘restrictive’ territory and the cashflow impact on the indebted household sector intensifying, we don’t think the RBA will need to do much more. We continue to see the RBA cash rate topping out at ~3.85%, possibly 4.10%, over the next few months, with the next 25bp hike not necessarily coming in April. The RBA could choose to wait until May, after the release of the next quarterly CPI report (26th April). A lot will depend on the upcoming retail sales (28th March), jobs (16th March) and monthly CPI indicator (29th March) prints.
The RBA continues to emphasize that while the “priority is to return inflation to target”, it is attempting to do this while keeping the economy on an “even keel” which is a tricky “narrow path” to navigate. The risks of a misstep lift with every rate increase from here, in our view, given the ‘long and variable’ lags and unintended consequences of policy changes. And the RBA is aware of the growth risks. We, along with the RBA, continue to foresee a sharp slowdown in domestic economic activity over 2023, with a material deceleration unfolding over H1 (see Market Wire: Growth Momentum Slowing). So far, the sharp jump in interest rates and mortgage costs have had their most visible impact across housing with the reduction in borrowing capacity generating a fall in new lending, reduced turnover, and lower prices. In time we expect these effects to broaden-out, with housing a key early moving cog in Australia’s economic machine. Monetary policy adjustments take time to play out, with the full impact tending to manifest only after ~4-6 quarters. As our chart below shows, given its deep supply chain, and other interconnections, housing touches a variety of sectors and large parts of the labour market.
In time an extended period of sub-trend growth should see unemployment rise and help bring inflation down. The RBA highlighted that the monthly CPI indicator “suggests inflation has peaked” in Australia, and we think this downtrend should continue as the mix of weaker demand, improved supply-chains and elevated inventories weigh on goods prices. At the same time, although services inflation is high, aggregate wage growth in Australia remains consistent with the inflation target, and as the RBA highlights while it remains “alert” to the possibility, recent data implies that a wage-price spiral locally remains a “lower risk”.
Market pricing for how high Australian interest rates could end up has adjusted lower once again after the tweaks in the RBA’s guidance. This has seen relative interest rate differentials move further in the US’s favour and has exerted some more downward pressure on the AUD. We expect the relative interest rate story to remain a headwind for the AUD given the stronger and stickier US inflation pulse. However, the higher level of commodity prices and China’s reopening should provide an offset. Our view remains that the AUD should find support around ~$0.66. That said, the diverging RBA and ECB outlooks, with the market now assuming the ECB could end up raising rates by more than the RBA this cycle, should continue to guide AUD/EUR lower, in our view. We continue to see more downside, and are looking for AUD/EUR to decline to ~0.60 (see Market Musings: Cross-Check: AUD/EUR – Shaky Foundations).