Interest rates: How high will RBA’s cash rates go?

A month ago, the cash rate was only expected to hit 50 basis points this month, but many economists expect bigger moves.

The median estimate of economists surveyed by Bloomberg is for the RBA to lift rates by 40 basis points on Tuesday. Picture: AAP

Robust economic growth and nascent inflationary pressures are fuelling bets of sustained interest rate rises by the Reserve Bank despite an emerging energy crisis that increases the risk of recession.

The median estimate of economists surveyed by Bloomberg is for the Reserve Bank to increase the official cash rate – now at 35 basis points – to its pre-pandemic level of 75 basis points at next Tuesday’s board meeting and keep lifting the monetary policy rate to 2.25 per cent by June 2023.

A month ago the cash rate was only expected to hit 50 basis points this month, but many economists expect bigger moves after the central bank surprised the market with an initial increase of 25 basis points.

A number of economists now see the cash rate hitting 85 basis points this month, an outcome likely to push mortgage rates up by 50 basis points. That would be the biggest increase in more than 22 years.

It comes as a quadrupling of coal prices in the past year, amid a global economic recovery, the war in Ukraine and maintenance closures at numerous coal-fired power generators boosts demand for gas at a time when its international price has also skyrocketed because of the issues in Europe.

A consequent fourfold rise in the wholesale cost of electricity since January has led the Australian Energy Regulator to allow ­energy retailers to raise prices to customers by more than 10 per cent.

Of the main contributors to inflation in recent quarters – utility costs, food and building materials – utility costs will be “most significant” from here as much higher electricity and gas prices were “yet to be recognised in household bills,” said JPMorgan Australia chief economist Ben Jarman.

Mr Jarman expects a further 10 per cent quarter-on-quarter increase in nationwide retail electricity prices in the September quarter, when most contracts are reset, and a similar rise in gas ­prices.

“These visible, salient inflation experiences could force a persistent reset in inflation expectations, and/or drive more cautious consumer behaviour,” he said.

Mr Jarman predicted the RBA would lift the cash rate by 40 basis points next week.

But the critical issue for markets is whether inflation can be brought under control by central banks without generating a recession – often defined as two consecutive negative quarters of growth.

“We think it can be – at least we can’t see a recession for the next 18 months – but right now the jury remains out,” said AMP Capital’s head of investment strategy and chief economist, Shane Oliver. He also expects a 40-basis-point lift in the cash rate next week.

Westpac chief economist Bill Evans maintains that a 40-basis-point increase next week is the “right decision”, saying: “That would eliminate the emergency stimulus from 2020 and send a clear signal that the board recognises its formidable task to move inflation back within the target band by 2024 and is prepared to act ­decisively.

“Clearly that emergency has passed and there is no justification to maintain an extreme emergency policy stance.”

The minutes of the RBA’s May board meeting pointed out that the case for 40 basis points “could be made given the upside risks to inflation and the current very low level of interest rates”.

“That case remained open without any real argument against it,” Mr Evans said.

“The lack of a clear argument against hiking by 40 basis points in May and the fact that they refer to the level of rates being ‘very stimulatory’ supports doing more than 25, thereby signalling the board’s commitment to achieving its inflation objectives and managing inflationary expectations.”

Goldman Sachs Australia chief economist Andrew Boak backed an even bigger rate rise of 50 basis points in both June and July and further rapid moves to a “terminal level” of 2.6 per cent this year.

“Against the backdrop of outsized rate hikes by key global peers, we see the risks as skewed towards the RBA front-loading the tightening cycle with 50-basis-point rate hikes in June and July,” Mr Boak said. In his view, the risks to normalising monetary policy from high household debt and the potential for an extended fall in house prices are “manageable”.

“Housing debt as a share of income has actually fallen materially since the Global Financial Crisis, the median Australian mortgagee is 21 months ahead on their mortgage repayments, seven years of macroprudential policy has substantially reduced risky lending, and our analysis on the composition of household debt and implied rise in the debt-servicing burden looks manageable.”

Bank of America expects the RBA to lift the cash rate by 50 basis points in June, July and August “in light of the magnitude of the task of addressing surging inflation from the current setting of policy”. Jim Chalmers had “set the stage for a reassessment of fiscal and inflationary trends at the start of the new government’s term”, and given a “green light for the RBA to signal a rapid normalisation of policy”, BofA economist Tony Morris said.

March quarter national accounts data this week showed “price pressures building up in the economy” in line with recent rises in consumer price inflation and the risk was that the central bank would also “signal that policy may need to move above neutral”, Mr Morris added.

The RBA has indicated that the “neutral” rate should be near its inflation target of 2.5 per cent.

Mr Morris expected the cash rate to hit 2.85 per cent in the first half of 2023.

But BetaShares said there was “no smoking gun” for a bigger rate rise this month.

“Although the RBA has long talked about anecdotes of stronger wage growth, the evidence for this in a range of available official data remains patchy – especially once allowance is made for the inherent volatility in some wage ­estimates,” chief economist David Bassanese said.

“Although wage growth could accelerate strongly, analysts who claim evidence of this already from official data appear to be clutching at straws.”

Similarly, CBA chief economist Gareth Aird said the RBA was likely to lift by 25 basis points: “The optics of delivering a larger than 25-basis-point increase in the cash rate in June might imply that the RBA board has changed their assessment of the outlook for inflation and inflation risks based on the change of government. That is not a message we believe the RBA would want to send.”