For the second straight meeting the RBA kept the cash rate steady at 4.35% today. This follows the rapid fire recalibration in interest rates that was pushed through earlier in the year. No change was widely anticipated with traders assigning a less than 5% chance of a move today and no surveyed analyst forecasting it. The decision to stand still was a unanimous Board vote.
According to the RBA, the impact of the Middle East conflict on inflation “has so far been less than expected”, yet headline inflation is “still too high” and trimmed mean “remains elevated”. But at the same time there continue to be “heightened uncertainties about the outlook”, and there are scenarios where “inflation is higher and activity lower” than assumed.
There are a lot of push/pull forces working their way through the domestic (and global) economy. It is a challenging time for policymakers, and for households/businesses across interest rate sensitive sectors. This was visible in the RBA’s updated economic forecasts which don’t paint a heartwarming picture. Australian GDP growth is projected to be quite sluggish for an extended time with a ~1.4-1.6%pa pace anticipated until mid-2028. Notably, the bulk of activity reflects population growth rather than productivity (chart 1). The resultant negative spillovers into the jobs market, and required capacity created in the economy, is predicted to dampen inflation over time. This can be a hard pill to swallow, but a prolonged period of sub-trend growth is typically the price that needs to be paid to slay the inflation dragon. On the RBA’s numbers Australian inflation may have peaked in Q2 (at a lower rate than previously assumed), but the move down to the midpoint of the target band could be gradual. Inflation is only forecast to edge down to 2.4%pa by 2028 (chart 2) with unemployment penciled in to lift to 4.8% over the next year or two (chart 3).
On our reading of the current state of play, and based on the latest outlook provided, the RBA appears to be a more reluctant rate hiker. The adjustment in policy settings at the start of the year, which the RBA now deems to have put things into “somewhat restrictive” territory, means policymakers are no longer chasing inflation higher. And while the door to further tightening remains open, it will be up to the data to trigger a move. According to the RBA, it will “continue to do what it considers necessary” to bring inflation to target, including increasing interest rates further “if upside risks materialise”. This ‘conditional’ tweak to the RBA’s guidance suggests the patient approach geared towards keeping the economy growing (albeit more slowly) and limiting the damage to the labour market adopted during the post-COVID hiking cycle might be back in vogue (chart 4). Time will tell. Another RBA rate rise can’t be definitively ruled out because of underlying inflation trends. Governor Bullock acknowledged that a hike was discussed today and that it is “quite possible” it may be required down the track, but the bar to it being delivered looks high, in our opinion. Markets seemingly agree with ~17bps of further tightening by the RBA factored into the Australian interest rate curve by next March.
For the AUD (now ~$0.7055), as mentioned previously, the positive impulse from the string of RBA interest rate rises that underpinned the jump earlier in the year is behind us. The RBA looks far closer to the end of its tightening phase (or it might already be there) while other central banks have room to run. The swing in the path for relative interest rates could, in our view, constrain the AUD’s upside potential (chart 5). Moreover, we believe other medium-term macro headwinds for the AUD remain. The list includes the unfolding slowdown in the Australian economy, ongoing issues for global/Asian growth stemming from the prolonged US/Iran conflict and disruptions to energy supply, lingering valuation worries and volatility across AI/tech stocks, and weakness in Asian currencies (chart 6).
