RBA more likely than not to hold rate steady
Economists are closely divided over the RBA’s rates move this week, but there’s more certainty the pain will return in August.
Money markets are betting the Reserve Bank is more likely than not to keep interest rates on hold after 12 hikes since May last year.
The RBA is set to meet on Tuesday to decide the next move on interest rates with financial markets currently pricing a 27.6 per cent chance of another rate hike.
Economists surveyed by Bloomberg are closely split on their outlook, with 13 expecting the RBA to hike rates for the 13th time, and 14 expecting the bank to hold fire.
But more pain for borrowers is expected in August, where financial markets are pricing in a 70.7 chance of a lift in the cash rate.
Meanwhile, economists at National Australia Bank and Westpac are tipping a terminal cash rate of 4.6 per cent.
This is despite inflation slowing in the US — the world’s biggest economy. The US Federal Reserve has announced it would pause its aggressive campaign of 10 consecutive interest rate hikes to tackle inflation in order to give policymakers more time to assess the strength of the US economy.
The US personal consumption expenditures (PCE) index — the measure of inflation the Fed watches most closely — eased to 3.8 per cent year-on-year in May, a significant drop from 4.3 per cent a month earlier, thanks to a sharp drop in energy prices, and food prices to a lesser extent.
But core PCE, excluding volatile food and energy prices, slowed only slightly to an annual rate of 4.6 per cent from 4.7 per cent a month earlier, indicating that inflation remains stubborn in many areas.
In Australia, the monthly CPI indicator has slowed to 5.6 per cent — its lowest level in more than a year — after hitting 6.8 per cent in April.
AMP Capital chief economist Shane Oliver said the “continuing downtrend” is a sign that inflation has peaked and “provides breathing space for the RBA to pause its hikes on Tuesday”.
But Dr Oliver said it was a close call.
“On balance we think that the RBA is likely to opt for another 0.25 per cent hike in the week ahead given its concerns about still high underlying inflation, sticky services inflation and rising wages growth,” he said.
“Either way the RBA will likely retain its tightening bias and we are continuing to allow for another two more hikes taking the cash rate to 4.6 per cent over the next few months.”
Dr Oliver said another 0.25 per cent rate hike would add an extra $100 a month on average to the cost of servicing a $600,000 home loan. This would take the total increase since April last year to an extra $1419 a month or $17,028 a year.
“Even if a borrower has secured a 0.5 per cent cut to their mortgage rate their payments would be up an extra $14,616 a year since April last year.”
Westpac chief economist Bill Evans is expecting another two 25 basis point hikes from the RBA on Tuesday and at its August meeting, lifting the cash rate to 4.6 per cent.
But he believes by then, the interest rate rises will be over.
“A terminal cash rate of 4.6 per cent is likely to be sufficient to achieve the (Reserve) Bank’s inflation objectives, although growth is forecast to slow to a crawl this year and next,” Mr Evans said.
“Westpac’s forecasts, which are based on a 4.6 per cent terminal rate, point to very weak growth in both 2023 (0.6 per cent) and 2024 (1.0 per cent) and an earlier achievement of the (2-3 per cent) inflation target than currently forecast by the RBA.
“Of most importance are indications that the board has, appropriately, adjusted its reaction function at the June meeting to prioritise containing inflationary expectations and addressing the risk, admittedly low, of a 1970s-style extended period of high inflation. Specifically, the minutes to the meeting noted that: ‘members discussed the possibility of implicit indexation of wages to past high inflation and the potential for this to become widespread’.”
CommSec chief economist Craig James said the RBA’s interest rate hikes have become “a coin toss”.
“Some observers would argue that the Reserve Bank should allow some time for previous rate increases to work their magic. Other gurus believe that rates need to keep lifting until the economy shouts ‘uncle,’ with the labour market remaining incredibly strong,” Mr James said.
“If rates don’t lift on Tuesday, they will be back on the menu for the August meeting.”
Despite the RBA’s aggressive interest rate hikes during the past year, the S&P/ASX 200 benchmark jumped 9.7 per cent in financial 2023, with Australian shares delivering surprisingly strong returns.
It was the best financial year since a 23 per cent surge in financial 2021, when corporate earnings and sharemarket valuations were boosted by an unprecedented amount of fiscal and monetary policy stimulus during the pandemic. It’s also well above the decade-average gain of 6.6 per cent.
In the next 12 months, Dr Oliver is expecting “reasonable sharemarket returns” as inflationary pressures ease and central banks “get off the brakes”.
“But the next few months are likely to be rough given high recession and earnings risks, uncertainty around US banks and poor seasonality out to around September/October. This is likely to impact both global and Australian shares,” Dr Oliver said.
“We continue to see shares doing okay on a 12-month view as central banks ease up as inflation cools but the risk of a near term correction is high.
“Leading economic indicators continue to point to a high risk of recession in the US and the risk of recession in Australia is now around 50 per cent. China’s recovery is looking less robust than expected and policy stimulus there so far has been pretty modest.”
Economists at Barclays say growth is slowing, but at different speeds across Western markets.
“US data signal only a gradual deceleration, while European indicators remain more downbeat and China is still not improving. Slower demand was reflected in softer core services inflation in the euro area and the US, with all focus now on next week’s US labour market data,” Barclays economists wrote in a note to investors.