Few positives for struggling households from inflation data and federal budget

The budget and inflation data are likely to exacerbate the pain for those juggling soaring food and energy costs with rising mortgages and rents, as rates expected to move on Tuesday.

Another move on the cash rate by the Reserve Bank is certain to increase pressure on spending. Picture: Nicki Connolly

A conservative budget and blowout inflation data this week gave little hope for households struggling with soaring food and energy bills, along with increasing mortgage and rent payments.

Still, while the budget missed a chance to trim national debt by cutting spending before the downturn hits, at least it didn’t add to the Reserve Bank’s task of controlling inflation.

At the same time, September quarter CPI data fanned expectations of more rapid-fire interest rate hikes in the coming months, as headline and core measures exceeded estimates and inflation broadened.

Several economists increased their “terminal rate” forecasts for the cash rate, and Westpac and Barrenjoey predicted the RBA will up shift to a 50 basis point rate hike on Tuesday.

But if the RBA gets on with the job now, it might not have to lift rates quite as high as it would have. That was part of the thinking behind a 27 basis point fall in market pricing of the terminal rate of cash to 3.95 per cent, which occurred even though the CPI blew out.

Market pricing of the RBA cash rate for December rose to 3.17 per cent from 3.06 per cent before the CPI data, implying a 76 per cent chance of the RBA delivering 75 basis points of hikes by the year’s end.

Some of the downward pressure on terminal rate pricing came from the broadening “pivot” toward smaller hikes by central banks globally, potentially due to financial system and economic risks. First, the RBA’s downshifted from 50 to 25 basis points in October. Then the Federal Reserve signalled via the last Friday that it may downshift from 75 to 50 basis points in December. And this week, it was the Bank of Canada’s turn to shock the market by downshifting to 50 basis points.

The European Central Bank’s widely expected decision to hike by 75 basis points this week wasn’t unanimous.

A rallying global bond market contributed to a 24 basis point fall in Australia’s 10-year government bond yield to 3.74 per cent. The three-year bond yield fell 28 basis points to 3.28 per cent.

But although expectations of near-term rate hikes by the RBA ramped up after the CPI data, market pricing of the terminal rate in Australia actually fell more than it did in the US. Part of the reason for that may have been the ramp up in expectations of year-end hikes by the RBA.

Commonwealth Bank head of Australian economics Gareth Aird.

Tuesday’s interest rate decision will be followed by a speech by RBA Governor Philip Lowe that evening. The quarterly Statement on Monetary Policy is due Friday.

The Commonwealth Bank expects the RBA to deliver two further 25 basis point rate hikes in November and December, taking the cash rate to an expected peak of 3.1 per cent.

The bank’s head of Australian economics, Gareth Aird, says the risk now sits with a higher terminal rate, but he still expects 50 basis points of rate cuts towards the end of 2023.

He says the “strength and breadth of price rises” in the inflation data means another rate hike is a “done deal” at the November board meeting, and the board will debate the case to raise the cash rate by either 25 or 50 basis points, as was the case at the October board meeting.

But he notes the board made a “very convincing case” in the October minutes as to why it decided to slow the pace of tightening. The board settled on 25 because of the risks to growth and the potential for inflation to subside quickly.

The minutes also made the salient point that the full effects of higher rates were yet to be felt in mortgage payments.

The arguments that underpinned the decision to raise the cash rate by 25 basis points in October will also be valid at the November meeting. Aird expects these factors to once again trump the case for a 50 basis point hike.

And arguments to hike by 50 basis points will be canvassed in the context of “stepping up the pace of tightening” rather than “continuing with 50 basis point increases” as was the case at the October board meeting.

“This creates an additional hurdle to raising the cash rate by 50 basis points,” Aird says. “The optics of dropping the pace of tightening in October and then stepping it up the following month would not look good. Such a decision would send a very confusing message.”

Indeed, the biggest time of the year for many retailers is just around the corner.

Aird emphasises the lags of monetary policy, particularly in terms of how it impacts price changes in the economy.

The RBA’s aggressive tightening cycle – 250 basis points between May and October – would have had no impact on the June or September quarter inflation outcomes. “Indeed, the rapid recent rate hikes and our expectation of some further modest tightening is unlikely to shift the inflation needle over the December quarter; inflation is a lagging indicator,” says Aird. “The impact of policy tightening will impact consumer inflation in 2023. That all said, in the context of an upside surprise on the third quarter CPI, we cannot dismiss the arguments the board made for continuing with an increase of 50 basis points at the October board meeting.”

Aird says it’s one thing to be the first major central bank to reduce the size of rate rises to a “business as usual” hike, but quite another to be the first major central bank to step up the pace of tightening, having just dropped it the previous month.