Economists lean towards fewer interest rate rises but any cuts would come much later

Economists are dialling back their expectations of more interest rate increases by the Reserve Bank but in turn many now predict the start of cuts will be further out than previously predicted.

Economists are dialling back their expectations of further interest rate rises after the ­Reserve Bank unexpectedly left rates on hold for a second consecutive month and forecast that inflation would fall to within its 2 to 3 per cent target range in late 2025.

However, rate rises are still seen as a risk for the next few months and rate cuts might be delayed, after the RBA left its cash rate target unchanged at a decade high of 4.1 per cent.

By Wednesday, three of the nation’s big four banks – Commonwealth Bank, Westpac and ANZ – were expecting no more rate rises, while National Australia Bank was expecting a final 25-basis-point lift in the cash rate to 4.35 per cent in ­November.

Morgan Stanley and Goldman Sachs trimmed their peak cash rate forecasts to 4.35 per cent, while AMP, Barrenjoey, Capital Economics, Oxford Economics and UBS scrapped their previous calls for more rate increases. HSBC and JPMorgan expected one more rate rise.

Deutsche and Citi continued to expect two more increases, but pushed out the timing to the end of the year.

The amount of further interest rate increase priced by cash rate futures – a better guidance than economist forecasts in recent months – fell to 12.5 basis points, from 25 basis points before the latest decision, implying a 50 per cent chance of a final increase in the cash rate of 25 basis points.

The market-implied yield curve showed the cash rate falling to 3.92 per cent by December next year.

Barrenjoey chief economist Jo Masters.

Increasing conviction among economists and traders that interest rates may have peaked, together with weak Chinese economic data and global risk aversion caused by Fitch Ratings downgrading the US’s credit ­rating, caused a 2 per cent fall in the Australian dollar. The currency dived from about US67c to a two-month low of US65.65c.

Meanwhile, the RBA’s quarterly statement on monetary policy, including updated forecasts, due on Friday, will give economist another opportunity to finetune their interest rate view.

Hope of fewer rate rises also gives hope to struggling households, but they will continue to feel the lagged impact of past increases on home loan rates and employment for 12 months or more – barring rate cuts – and any rebound in consumer confidence and house prices may be ­limited.

The RBA maintained that “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable time frame, but that will depend upon the data and the evolving assessment of risks.”

Barrenjoey chief economist Jo Masters said the RBA’s statement suggests the board believes there was sufficient tightening already in the system to lower inflation to the target band by mid-2025.

“We think the RBA wants to be done and it would take an accumulation of data surprises to force a dovish board back to the table. Meetings are still live, but the onus is on the data and the bar is high,” Ms Masters said.

“The risk is now that the RBA will be later to the easing cycle than other central banks.”

CBA said it would probably take an upside surprise to the economic data from here, particularly on prices and wages, for the RBA to shift its assessment of the outlook, after strong June jobs ­appeared not to have changed the central bank’s assessment of the labour market.

Commonwealth Bank senior economist ­Belinda Allen. Picture: Bob Barker

CBA is the most dovish of the major banks on the interest rate outlook. It expects 1 percentage point of rate cuts next year, starting with a 25-basis-point cut to 3.85 per cent in the March quarter.

“We expect the economy to have slowed, inflation to have moved down closer to target and the labour market to be softening to prompt the start of the easing cycle,” CBA senior economist ­Belinda Allen said.

Of most interest to economists is that the RBA left rates on hold again in August – its first two-month hold since it started lifting rates in May last year – even though it continued to forecast that CPI inflation would be above the top end of its 2-3 per cent target band for two more years.

Inflation has been above the top of the band since mid-2021, risking a rise in inflation expectations that could lead to a prices-wages spiral.

That could force the RBA to deliver large rate increases, as ­occurred in the 1980s and early 1990s.

“The RBA’s statement could have been very similar, but with a different decision on the cash rate,” UBS Australia chief economist George Tharenou said.

“This implies a dovish shift in the RBA’s ‘reaction function’.”

Mr Tharenou correctly predicted the outcome of every RBA meeting from mid-2022 until this month’s meeting, at which he had expected the RBA to announce a final rate increase.

The RBA said June quarter CPI inflation was “declining but is still too high at 6 per cent”. It continued to see headline CPI inflation around 3.25 per cent by the end of next year, and unemployment rising to just 4.5 per cent – the RBA’s current estimate of the non-accelerating inflation rate of unemployment – 1 percentage point above its June level of 3.5 per cent.

“The RBA held despite expecting to miss their mandated goals for inflation until at least 2025,” Mr Tharenou said.

UBS Australia chief economist George Tharenou said. Picture: Hollie Adams

“Hence, to hike in September or October based on monthly data seems unlikely.”

Looking further out, a lower expected terminal cash rate points to an even longer-than-normal peak level of 14 months, implying no rate cuts until August 2024, according to Mr Tharenou.

“We think risks are still tilted towards more tightening, given that unemployment is close to a historic low, and the upside risk to house prices from an extended hold, which could support spending. But, Tuesday’s decision makes us unconvinced the RBA will act on stronger data,” he said.

Deutsche Bank Australia chief economist Phil Odonaghoe questioned whether rate rises were ­finished.

“Naturally, many will be asking whether two consecutive unchanged decisions suggests that the RBA is now ‘done’ for this hiking cycle,” Mr Odonaghoe said.

“We think not, and continue to expect two more hikes from the RBA.”

Mr Odonaghoe said the hurdle for more rate rises by the end of this year wasn’t “insurmountable”. He said it was unclear that the unemployment rate would rise meaningfully above a 50-year low this year as the RBA expected.

He also noted that the Bank of Canada’s interest rate “hold” from January to June ended with two more rate rises, and that the increasing chance of a US soft landing could well require an upward recalibration of rates in Australia.