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In what we believe was yet another finely balanced call the RBA held the cash rate steady at 4.1% at today’s meeting. This maintains the cumulative tightening delivered so far this cycle at 400bps. This is the sharpest RBA tightening cycle since at least the early 1980s, and we don’t think the RBA is done.

The RBA once again noted that while inflation has passed its peak it “is still too high” and “will remain so for some time yet”. However, considering the sharp increase in rates that has already been put through and uncertainty around the outlook, a decision was made to hold steady “this month”. The specific reference to “this month” was repeated elsewhere in the statement and indicates that today’s hold was more akin to a ‘skip’ than the end of the line. Indeed, in line with recent months the RBA retained a conditional tightening bias, noting that “some” further policy tightening “may be required”, and that trends in the global economy and household spending, and “forecasts” for inflation and the labour market, which will be updated at the 1 August meeting post the quarterly CPI report (released 26 July), will be inputs into its decision.

We continue to see the RBA raising the cash rate to 4.35% in August given the inflation impulses (see Market Wire: RBA: hiking until it hurts). As our chart illustrates, unit labour costs have accelerated, and without a productivity offset, this is raising the odds a wage-price spiral develops, and that underlying pressures (especially ‘sticky’ services prices) become entrenched. The RBA remains focused on returning “inflation to target within a reasonable timeframe”, with its current timeline looking for CPI to return to the top of its 2-3% target band by mid-2025 in doubt.

However, such an elevated level of interest rates isn’t going to be economically painless. To break the back of a services-driven inflation problem a prolonged period of sub-par growth and higher unemployment is what is typically needed. It is a hard pill to swallow, but history shows this is what slays the inflation dragon. As we have pointed out before, based on the high level of household indebtedness, as interest rates move deeper into “restrictive” territory and the longer they stay there, the negative economic impacts should accumulate. There is no sugar coating it, but the rate rises in May and June, followed by another one in August, are the ones that should really hurt.

Strong population growth following the reopening of international borders may help cushion the blow and prevent the economy from going backwards in aggregate (note, GDP is a volume measure), but the slide in activity on a per capita basis is set to extend. Indeed, as the substantial cashflow hit on the household sector builds, particularly as the large amount of fixed rate refinancing takes place and other cost-of-living pressures continue to bite, we expect consumption and broader growth to slow considerably over H2 2023 and early-2024. As shown, we are currently in the eye of the fixed rate refinancing storm, and this roll-off should generate a fair amount of additional ‘natural’ tightening over the period ahead. Over time, we think the deceleration in momentum will flow through into business investment and the labour market. Unemployment (now 3.6%) is forecast to lift over the next year.

With a ~32% chance of a rate rise factored in ahead of today’s RBA meeting, and ~1/2 of market analysts looking for the RBA to hike, the AUD has given up a bit of ground (now ~$0.6655). Over the near-term, as the RBA decision is digested, we think the downward pressure on the AUD can continue. Later this week we think the risks are tilted to the US labour market report showing ongoing strength. This could support an upward shift in US interest rate expectations and be USD supportive. Crosses such as AUD/EUR and AUD/GBP may also remain on the backfoot as relatively more hawkish outlooks from the ECB and Bank of England are maintained and the global economy continues to slow. This backdrop is more of a negative for the cyclical AUD.

That said, although we see a bit more near-term downside in AUD/USD we also don’t want to be overly bearish down around current levels. While we don’t see the AUD snapping back sharply for a while yet given the sluggish global growth pulse, we also think that fundamentals such as Australia’s current account surplus (now ~1.4% of GDP) and the high level of the terms-of-trade should act as downside cushions. As we have seen repeatedly over the past few years the AUD has tended to find solid support just below where we are currently tracking. On our figuring, since 2015, when these factors kicked into gear, the AUD has only traded sub-$0.6650 ~6% of the time.

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