As long as inflation remains above target, there’s a risk that inflationary expectations will drift further, in which case they would be costly to address, the governor of the Reserve Bank Michele Bullock said on Tuesday at her first post-meeting press conference, echoing the hawkish statement that accompanied the rate decision.
“There’s more work to do,” Ms Bullock said, after the central bank held rates at 4.35 per cent and confirmed that it is leaving the door open to future rate rises.
But despite the bank’s decision not to drop any hints regarding the potential end to the fastest tightening cycle in decades – something the market is pricing in for the second half of the year – the RBA did revise its inflation forecast slightly and now predicts the consumer price index (CPI) to drop to 3.3 per cent (instead of 3.9 per cent) by June.
From there, however, inflation is expected to ease at a snail’s pace, reaching 3.2 in December and 3.1 per cent six months later. By the end of 2025, inflation is expected to finally hit the target band by reducing to 2.8 per cent, before dropping further to 2.6 in June 2026.
The RBA also slightly lowered its growth forecasts, pencilling in GDP growth of 1.8 per cent at the end of this year, instead of 2 per cent, and 2.3 per cent at the end of 2025 – or 0.1 per cent lower than earlier predicted.
Commenting on these revisions to the bank’s earlier forecasts, Ms Bullock said the RBA is “not ruling out anything” and that it will solely base future decisions on data.
Ms Bullock is not fazed by market pricing, she said, which had pencilled in two rate cuts by the end of the year prior to Tuesday’s rate announcement.
“We don’t think of market pricing as being a forecast of our own cash rate,” the governor said.
“Markets will make their own decision and they are putting their money where their mouth is on those sorts of things. But we’re not driven by market pricing. What’s important for us is looking at the economic data.”
The economic data is currently suggesting robustness and resilience despite 13 rate hikes since May 2022. However, Australia’s productivity is often cited as a major challenge, with the country’s Productivity Commission last year raising alarm bells and urging an increase in investment and innovation to ensure growth.
Ms Bullock is confident that productivity “will return to the Australian economy” in the long-term and said that concentrating on the quarterly movements isn’t “particularly helpful”.
“We need to take a step back. We have assumptions in our forecast that productivity will return to some sort of long-run trend that will be positive, because that’s really important for the economy to keep growing.
“I’m confident that that will occur.”
Economists maintain confidence
Economists and fund managers broadly characterised the RBA’s tone on Tuesday as hawkish, but despite this, most still believe rate cuts are on the cards for 2024.
Commonwealth Bank said that while the board is obviously in no hurry to declare the inflation fight over, its communication strategy is slanted towards households, businesses and policymakers rather than market participants.
“Maintaining a tightening bias signals to the fiscal authorities that it’s too early to declare the inflation fight over.
“The RBA would not wish to see fiscal settings loosened until further progress on inflation has been made towards the target band,” CBA’s economists said.
Despite this, the big bank maintained its central scenario which sees the RBA commence an easing cycle in September 2024, with the cash rate said to reach 2.85 per cent by mid-2025.
Similarly, describing the RBA’s statement as hawkish, Westpac said it does not expect any further rate increases by the RBA this cycle.
“Rate cuts are still some way off, though,” its economist, Luci Ellis, said.
“We continue to expect the RBA to reach this level of comfort around September.”
AMP’s chief economist, Shane Oliver, remains a little more optimistic and believes that the bank has actually “soften” its “mild tightening bias” since December last year.
He believes the bank will adopt an easing bias by the May meeting, before pivoting to rate cuts mid-year.
Nevertheless, Dr Oliver said: “Our assessment remains that the combination of weaker growth and a faster fall in inflation than the RBA currently expects will ultimately force its hand and we continue to see it cutting rates from mid-year with three 0.25 per cent rate cuts by year end, taking the cash rate down to 3.6 per cent by December.”
ANZ, however, believes cuts probably won’t take place until November, on account of the stage three tax cuts, but admitted future inflation data may impact this forecast.
“Our own views remain unchanged on account of the post-meeting statement,” the bank said.
Dr Dwyfor Evans, head of APAC macro strategy at State Street Global Markets, said the bank’s comments on Tuesday were “slightly more hawkish” than anticipated.
“Certainly not the neutral to dovish report that some would have anticipated after the most recent CPI report but we continue to focus on weaker consumption, elevated debt servicing costs and signs of easing in the job market as pointers towards a more accommodative stance going forward, albeit one that the RBA did not necessarily deliver in its messaging today,” Dr Evans said.
Implications for investors
Vanguard’s Asia-Pacific chief economist, Qian Wang, said she expects the RBA to keep the cash rate constant, with potential rate cuts only occurring in the second half of this year.
As such, Ms Wang said, “We remain cautiously optimistic on the outlook for markets.”
“Long-term yields – a strong predictor for expected returns over the long-term – are now back at a level last seen before the GFC in 2008. This has raised our expected returns for global bonds to 4.5 per cent to 5.5 per cent annualised over the next decade, almost 3 per cent higher than before the rate hiking cycle began”.
Meanwhile, she explained, equities may find some rate relief in the near term, but the persistence of a higher rate environment is expected to present headwinds for global equity earnings and valuations.
“We expect global equities to return 5.1 per cent to 7.1 per cent annualised over the next decade.
“The return to positive real interest rates provides a solid foundation for long-term risk-adjusted returns. While expected returns for risky and defensive assets have drawn closer, we continue to expect equities to maintain a modest risk premium over bonds.”
