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RBA pause provides ‘false sense of security’

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By Charbel Kadib
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5 minute read

Economists continue to anticipate further hikes from the Reserve Bank, despite its latest decision to keep rates on hold.

The official cash rate was held at 4.1 per cent following the Reserve Bank of Australia’s (RBA) monetary policy board meeting on Tuesday, 4 July.

Market expectations were mixed, however, a number of senior economists, including representatives from three of the big four banks, projected a 25 bps hike.

In its post-meeting statement on monetary policy, the RBA said the pause would provide the central bank with “some time to assess the impact of the increase in interest rates to date”, as well as broader macroeconomic developments amid continued “uncertainty”.

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The RBA has actioned a cumulative 400 bps in increases to the cash rate since commencing its monetary policy tightening cycle in May 2022.

“The higher interest rates are working to establish a more sustainable balance between supply and demand in the economy and will continue to do so,” the RBA stated.

However, the Reserve Bank remains determined to return inflation to the 2–3 per cent target range and flagged the risks of an entrenched inflation scenario.

This was despite the latest monthly consumer price index (CPI) print, which reported headline inflation of 5.6 per cent, well below market expectations of 6.1 per cent.

“… Inflation is still too high and will remain so for some time yet. High inflation makes life difficult for everyone and damages the functioning of the economy,” the RBA continued.

“It erodes the value of savings, hurts household budgets, makes it harder for businesses to plan and invest, and worsens income inequality.

“…If high inflation were to become entrenched in people’s expectations, it would be very costly to reduce later, involving even higher interest rates and a larger rise in unemployment. For these reasons, the board’s priority is to return inflation to target within a reasonable timeframe.”

The central bank acknowledged labour market conditions have “eased”, but “remains very tight”, with the latest data reporting a fall in the unemployment rate to a near record-low of 3.6 per cent.

These pressures have been exacerbated by wages growth, which for the time being, “is still consistent with the inflation target”.

Ultimately, the Reserve Bank has left the door open to further hikes to the cash rate in the coming months.

“Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve,” the RBA added.

“The decision to hold interest rates steady this month provides the board with more time to assess the state of the economy and the economic outlook and associated risks.”

Among the economic indicators to be assessed by the RBA ahead of future monetary policy board meetings are developments in the global economy, trends in household spending, and the forecasts for inflation and the labour market.

“The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that,” the RBA concluded.

According to Dr Dwyfor Evans, head of APAC macro strategy at State Street Global Markets, the Reserve Bank’s decision to pause its tightening cycle in July resembles the US Federal Reserve’s hawkish skip last month.

“…The prospect for additional tightening indicate remarks somewhat similar to recent Fed rhetoric and again the impact of higher wages and a tight labour market were highlighted,” he said.

“This looks a wait-and-see meeting and a gauge of impact from previous tightening. The bias of the remarks are sufficiently hawkish to keep further hikes on the table and ensure August remains a live meeting for policy change.”

Russel Chesler, head of investments at VanEck, said the pause could give observers a “false sense of security”.

“Just because the RBA holds steady in July doesn’t mean another rate rise isn’t around the corner in August,” he said.

“Given the RBA’s mandate, the central bank may have no choice but to hike rates even higher than markets have anticipated.

“Indeed, there is now a real chance the RBA pushes rates above 4.6 per cent.”

Mr Chesler’s sentiment is shared by ANZ Research and AMP Capital, which continue to forecast two additional 25 bps hikes before the tightening cycle draws to a permanent close.

But AMP’s chief economist, Shane Oliver, said he believes the RBA’s previous hikes would be enough to quell inflation.

“We think that the RBA has done more than enough on rates to slow the economy and bring inflation back to target,” he said.

“Continuing to raise rates from here will add to the risk of recession that we already put at 50 per cent.

“However, the RBA retained its tightening bias and given still high inflation, the still tight labour market and the RBA’s still hawkish guidance, we are allowing for two more rate hikes — one in August and one in September taking the cash rate to a peak of 4.6 per cent.”

Meanwhile, the Commonwealth Bank, which correctly predicted a pause in July, has backed its base case projection of one final hike in August, taking the terminal cash rate to 4.35 per cent.

However, CBA conceded the upcoming quarterly CPI print, due on 26 July, is a risk to its forecast.

RBA pause provides ‘false sense of security’

Economists continue to anticipate further hikes from the Reserve Bank, despite its latest decision to keep rates on hold.

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