In what was Governor Lowe’s last meeting at the helm the RBA kept the cash rate steady at 4.1% for the 3rd straight month. This wasn’t a surprise with the recent wave of weaker activity data, slowing inflation, and sluggish growth in China supporting the case for the RBA to stand pat as the full effects of its past moves continue to work their way through the economy. According to the RBA the tighter policy is “working to establish a more sustainable balance between supply and demand in the economy”, and the decision to hold fire again in September “will provide further time to assess” the impacts of the jump up in interest rates.

That said, as per its recent commentary the door to further action remains slightly ajar, with the RBA once again retaining its mild conditional tightening bias. In a repeat of its prior guidance the RBA thinks “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe”, but the decision to act will be driven by how the incoming data and assessment of risks evolves. In our opinion, the bar to crystalise this mild bias and hike rates further looks quite high. While inflation is “still too high” and there are risks that services price inflation surprises as it has overseas, we think the growth side of the story and potential negative financial stability consequences from an abrupt economic slowdown and/or spike in unemployment favour an on hold stance.

Momentum across the interest rate sensitive sectors of the Australian economy has slowed. We believe this trend will continue (and potentially worsen) over the period ahead as the substantial cashflow hit on the indebted household sector intensifies (particularly as the higher level of interest rates is maintained), more COVID-era low fixed rate loans are refinanced, other cost-of-living pressures continue to bite, and amplifiers such as high debt levels and rising unemployment kick in. Indeed, the RBA expects the current period of below-trend growth to “continue for a while”, which in turn points to the unemployment rate edging up to ~4.5% late next-year, and for inflation to be back within the 2-3% target band “in late-2025”.

The AUD has been under broad-based downward pressure over the past few weeks, in line with the usual negative seasonal patterns at this time of year which we had flagged (see Market Musings: History doesn’t repeat, but…). Deteriorating sentiment around the outlook for Chinese growth, a run of weaker Australian economic data, and upward repricing in US interest rate expectations on the back of a stronger than anticipated US data pulse have combined. But down around current levels (now ~$0.6405) we think the pull-back in the AUD has largely run its course, with a lot of negatives now appearing to be factored in. It is important to remember that FX is a relative price, outcomes compared to expectations are what drive markets, and when it comes to the AUD offshore developments tend to matter more than domestic macro trends. When throwing this into the mix, we see the AUD soon levelling off before commencing a slope rope climb over the coming months back into the low ~$0.70s by mid-2024.

From our perspective, structural downside supports stemming from Australia’s current account surplus (~1.2% of GDP) and the high level of the terms-of-trade remain in place. Since 2015, when these dynamics asserted themselves, the AUD has only traded below current levels ~2% of the time. Cyclically we also believe the tide may (slowly) be turning in favour of a AUD rebound. Authorities in China have started to roll-out growth and FX supportive measures. A relative improvement in China’s economic fortunes should be a tailwind for regional growth, commodity demand, and the AUD over time. Similarly, given a ‘higher for longer’ US Fed interest rate view now appears to be adequately factored in we think the USD’s upswing may be nearing its end, with the USD appearing vulnerable to softer US data. With US ‘excess savings’ now largely depleted, credit standards tightening, and the labour market starting to turn south, this is where we believe the risks reside going forward.