The Reserve Bank of Australia’s (RBA) decision to hike the cash rate by a further 25 bps in June has, according to observers, marked a shift in the central bank’s “narrow path” strategy, which aims to return inflation to the 2-3 per cent target without reversing inroads in the labour market.
The RBA’s 400 bps in cumulative increases since May 2022 has taken the cash rate to 4.1 per cent from its COVID-era record-low of 0.1 per cent.
The rapid “normalisation” of interest rates, however, has surprised observers, which had expected the RBA to wind down the hiking cycle amid signs of sustained disinflation.
Economists have now revised their forward projections, with the June decision pointing to a sustained hawkishness in the RBA board’s outlook.
The Commonwealth Bank, which had called a terminal rate of 3.85 per cent, is now forecasting at least one more hike in August, taking the peak cash rate to 4.35 per cent.
However, the bank flagged the risks of hikes in both July and August, lifting the cash rate to 4.6 per cent.
HSBC Australia chief economist Paul Bloxham has also updated his cash rate outlook, calling a terminal cash rate of 4.35 per cent.
“There appears to have been a distinct shift in the RBA’s reaction function recently, with the central bank becoming more concerned about high inflation embedding itself in the economy,” he said.
“The RBA’s earlier approach seemed to indicate a greater tolerance to risks concerning the speed with which inflation returns to its target.”
Mr Bloxham attributed the shift to changing wages growth expectations, fuelled by the Fair Work Commission’s recent decision to lift the minimum wage by 5.75 per cent.
Adding to this was signs of a weakness in productivity and the subsequent surge in unit labour costs, and “sticky” services inflation in international markets.
“Despite the fact that the RBA’s tightening is already slowing growth and that much of the effect of the already-delivered tightening is yet to fully flow through to the economy, it seems the central bank has lost patience with waiting for inflation to fall,” he said.
Moreover, both CBA and HSBC have pushed back their projections for interest rate relief, and no longer anticipate cuts to the cash rate in the back end of 2023.
“We have pushed out the timing of the start of rate cuts from Q4 23 to Q1 24 — we expect 125 bp of easing in 2024 (50 bp of rate cuts in Q1 24 and 25 bp of easing in each of Q2 24, Q3 24 and Q4 24, which would take the cash rate to 3.1 per cent at end 2024),” CBA noted.
“We believe policy easing will be required of this magnitude over 2024 to avoid the unemployment rate lifting back to 5.0 per cent — around the level it sat pre-pandemic, which is above most estimates of the NAIRU (non-acceleration inflation rate of unemployment).
“It is possible that the RBA leaves policy on hold for an extended period in 2024 if inflation proves hard to return to target and unit labour costs don’t decelerate enough.”
HSBC does not expect cuts to the cash rate until the second quarter of the 2024 calendar year, with the cash rate projected to fall to just 3.5 per cent by the end of next year.
Tighter-than-expected monetary policy settings are expected to dent hopes of a “soft landing” from inflationary heights, with CBA and HSBC claiming there’s a 50/50 probability of a recession.
According to the latest national accounts data, Australia’s GDP grew 0.2 per cent over the three months to 31 March 2023, down from 0.6 per cent (revised up) in the December quarter.
The March quarter result fell below market expectations of a 0.3 per cent increase.
In annual terms, GDP grew 2.3 per cent in the 12 months to March 2023, down from 2.8 per cent in the previous quarter and from 3.3 per cent in the previous corresponding period.
GDP per capita also fell, dropping from 0.8 per cent in the 12 months to 31 December 2022 to 0.3 per cent over the year to March 2023.
However, the RBA’s tightening bias has been reinforced by an “upside surprises” on inflation in Australia and overseas, wages growth, and housing prices.
In a recent address to participants at the Morgan Stanley Australia Summit, governor Philip Lowe stressed that despite these perceived policy shifts, the RBA remains resolute in its commitment to tackle inflation.
The latest monthly consumer price index (CPI) reported an annualised inflation of 6.8 per cent in April — the first acceleration in 2023.
Wages grew 0.8 per cent over the March quarter and 3.7 per cent in annual terms, with the Fair Work Commission’s recent decision to lift the minimum wage by 5.75 per cent stoking fears of a wage price spiral.
National home values have now increased for three consecutive months, with CoreLogic reporting a 1.2 per cent increase in May preceded by a 0.5 per cent rise in April and a 0.6 per cent increase in March.
“We felt like we couldn’t just sit idly and say, ‘well, this is just all accidental — it’s all just noise’,” governor Lowe said.
“The conclusion we reached was that this represents upside risks to the inflation outlook in Australia.
“We have been prepared to be patient and get inflation back to target but our patience has a limit, and the risks are starting to test these limits.”