To ensure a soft landing for the Australian economy, the Reserve Bank (RBA) will need to adopt a dovish approach, according to a new report from UBS.
The multinational investment bank predicted fewer rate hikes than markets expect in the coming months, with rate cuts expected to materialise in the second half of 2023.
While markets are pricing in a cash rate peak of around 3.9 per cent by mid-2023, UBS believes the RBA will deliver one more 25 bp hike in December, taking the peak to 3.10 per cent. It did, however, flag some risk of another 25 bp hike in February depending on the Q4 CPI result.
UBS then expects the central bank to pivot to rate decreases, with two 25 bp cuts in store for the second half of 2023, followed by a further 50 bp rate cuts throughout the first half of 2024.
It did, however, note that these are dependent on the US Federal Reserve also delivering cuts.
“In the last 30 years, the RBA always started cutting cycles despite year-on-year headline CPI above their 2 to 3 per cent year-on-year target (excluding during COVID-19 when CPI was already below target), and also stopped hiking cycles before year-on-year CPI peaked,” said UBS economist George Tharenou.
“Historically, the RBA also cut rates during the past six home price downturns (>2 per cent), albeit typically only after home prices fell for ~10 months (or by ~5 per cent).”
With inflation much higher this cycle, surging to 7.3 per cent annually in the third quarter, UBS said the RBA will be a bit less dovish and will keep hiking rates until the CPI peaks.
“Supporting our view has been the recent dovish shift by the RBA towards the financial stability part of their triple mandate (and now with less focus on actual inflation and full employment),” said Mr Tharenou.
The firm suggested that, as real GDP slows and unemployment rises, the RBA will likely become more forward-looking and ease monetary policy even though inflation is likely to remain above target.
The RBA announced last week that headline inflation is now forecast to peak at 8 per cent.
As a result, UBS said that CPI “is unlikely to materially surprise the RBA to the upside, in contrast to global trends”. The bank expects inflation to slow to around 3.5 per cent by the end of 2023, and to reach the RBA’s target band by the fourth quarter of 2024.
GDP is seen to grow at 4.0 per cent year on year in 2022 before slowing to 1.8 per cent year on year in 2023, with momentum said to drop towards 1 per cent year on year by the fourth quarter of next year.
“This would be far below ‘trend’, and the slowest since 1991 (excluding COVID-19). Our view is a bit more negative than consensus and the RBA, but we still see a ‘soft landing’ that avoids a material recession,” Mr Tharenou said.
Moreover, UBS expects rate hikes to more than double household interest payments and see household cash flow drop to a record low of around 1 per cent year on year by H2 2023.
“The hit to consumption is exaggerated by the end of the rundown in household savings, which is allowing spending to grow faster than income,” said Mr Tharenou.
“Furthermore, there is a building ‘mortgage cliff’, especially around ~mid-23, due to the expiry of fixed-rate home loans, with borrowing rates to spike for ~one-third of borrowers, from ~2.25 per cent towards ~6 per cent.”
House prices, which have been in decline nationally for the past half year, are expected by UBS to suffer a peak-to-trough fall of around 15 per cent, with negative impacts on turnover and confidence.
“However, we then look for real GDP to stabilise around 1.6 per cent year on year in 2024 (consensus: 2.0 per cent), albeit requiring ~100 bps of RBA rate cuts, the legislated stage three income tax cuts (from mid-24), and strong population growth (~1.4 per cent year on year)”, Mr Tharenou noted.
