article 3 months old

RBA: Not Over Yet

Australia | May 03 2023

The RBA rate hike surprised the market but not economists, who largely believe there are still more hikes to come.

-Market caught out by RBA hike
-Recent data/evidence likely drove decision
-Economists largely see another hike yet to come

By Greg Peel

Ahead of yesterday, the futures market had priced in a 91% chance the RBA would pause its rate hikes for a further month rather than hike again so soon after pausing in April. The April statement implied the board wanted to pause to allow the lagged effect of hikes on the economy to catch up, before deciding on the next move.

On that basis, one month would never be much of a pause when the lagged effect could take between six and eighteen months, although it’s now been twelve months since the RBA began hiking.

Such confidence the RBA would continue to pause belied what was revealed in the minutes of the April meeting, released later in the month. They suggested the April pause was not specifically to allow the economy to catch up, but rather to await the latest economic data that would inform whether things were on the right track. The most predominant of these was the March quarter CPI report, released last week.

While at 7.0% the headline CPI came in below the board’s forecast, the core CPI, while lower, was not meaningfully lower, and highlighted that services inflation (eg rents for one) remained “sticky”.

In justifying the decision to hike again yesterday, the statement noted:

“But services price inflation is still very high and broadly based and the experience overseas points to upside risks. Unit labour costs are also rising briskly, with productivity growth remaining subdued.”

Speaking in Perth last night, the RBA governor explained the decision to increase the cash rate target to 3.85% came down to evidence the labour market remained very tight, and persistent global inflation and services price inflation in Australia. Furthermore, looking overseas suggests the services based inflation risks are to the upside given the “high degree of commonality across countries in inflation dynamics recently“.

Higher house prices were not mentioned as a reason for the rate increase anywhere in his speech. Nor did the Governor make reference to stronger labour supply from higher net overseas migration, something the RBA had previously said could help manage labour market pressures. This omission may suggest the RBA does not view higher working age population growth as sufficient to balance higher labour demand right now.

The RBA rate hike surprised the market but not economists, who largely believe there are still more hikes to come.

Not Mentioned

While Philip Lowe may have made such omissions in his speech, responding yesterday to the decision Jarden suggested there were likely three key factors determining the rate hike decision: upside surprise to migration/population growth, the risk of larger Award and Enterprise Bargaining Agreement (EBA) wage increases, and the stabilisation/recovery in the local housing market.

Jarden believes the recent surge in migration is likely inflationary in the short term and the RBA clearly agrees, with the April minutes noting this was "somewhat inflationary". Jarden assumes this, along with recent research on the rental market, has likely partly driven the more hawkish tone and largely unchanged CPI forecasts, despite the lower than expected outcome in the March quarter.

The recent acceleration in EBA wages, along with the upside risk to Award wages this year, also likely played a role. Indeed, the minutes noted "increased risk of larger wage increases in parts of the economy".

Finally, the earlier stabilisation and recovery in the housing market (average price up 0.7% in April) has come as a surprise to most and brings with it upside risk to consumer spending and inflation. Together, Jarden suggests, these upside risks likely meant the RBA could no longer credibly expect to reach its inflation target by mid-25 without further hikes.

Also writing ahead of the speech, Morgan Stanley noted the May statement does not read materially different to the April one, which raises the question of why the RBA didn't choose to wait longer to "assess the lagged impact of prior hikes".

Morgan Stanley looks ahead to Friday’s Statement on Monetary Policy for more detail, but would point to 1) upside risks to wages growth over the second half 2023, as flagged in the April minutes; 2) the positive sentiment and risk response (especially housing) to the pause the prior month; 3) less downside risk in the global economy.

Ain’t Over Till It’s Over

While the market may have been caught out by the rate hike, economists were generally not, other than the brevity of the April pause. Economist consensus has been for further rate hikes to be needed, and while we now have a May hike, that won’t be the end of it. A terminal (peak) rate forecast of 4.10%, ie one more hike, is most popular.

It all comes down to the timing, vis a vis the economic data due to flow over coming months.

In their responses, economists have highlighted a subtle change in the statement in May, which included "Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe,” from April’s "some further tightening of monetary policy may well be needed to ensure that inflation returns to target”.

So, what’s a “reasonable timeframe”?

Given the RBA paused for only one month before hiking again, we can assume quarterly CPI data are fundamental. The June quarter CPI data will not be out until the August meeting.

To that end, Morgan Stanley expects the RBA to pause again before moving in August dependent on the CPI result, but does point out there are other no less important indicators to be released in between.

These include next week’s federal budget and the wage growth data due ahead of the June meeting, and the March quarter GDP result, Unit Labour Cost data and minimum wage decision ahead of the July meeting.

ANZ Bank suggests that given its own concerns about the stickiness of services and non-tradables price inflation, and the robustness in the labour market and the business sector, its forecast for a 25 point rate hike in August is retained.

UBS, which had expected yesterday’s hike, suggests the most likely timing of the next hike will be July.

Citi sees another rate hike as still likely, but the risk is that the RBA could choose to pause again before further tightening monetary policy, drawing out the policy cycle for longer.

Jarden is less specific, arguing the addition of "a reasonable timeframe" in the statement suggests a strengthening of the RBA’s resolve and, while it is not defined, would imply that any slippage from the RBA's expectation of inflation returning to 3% by mid-25 would warrant further tightening.

Westpac’s economists are in a different camp:

“Going forward the weakness in the economy and slowing inflation is likely to eventually see the tightening bias fade; rates remain on hold for the remainder of the year with rate cuts beginning in the March quarter next year.”

We await the subsequent data.

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