Inflation ‘clearly still above the target band’ says RBA chief economist Sarah Hunter

Speculation of a rate hike by the Reserve Bank is creeping back into the money market where chances of a hike gained ground off the back of inflation data.

Interest rate hike jitters weigh on stocks after inflation blowout. Picture: David Crosling/NCA NewsWire

Speculation of another interest rate hike by the Reserve Bank is creeping back into the money market despite cost-of-living relief in the budget, which aims to lower inflation to allow for rate cuts.

While economists at the nation’s big four banks still expect the RBA to cut its cash rate target by 25 basis points to 4.10 per cent in November, overnight index swaps implied an 18 per cent chance of a hike to 4.60 per cent, up from virtually no chance before the latest inflation data.

A rate cut was priced as only a 19 per cent chance by April 2025, down from 42 per cent before the monthly CPI data.

It showed an unexpected pick-up in inflation to 3.6 per cent on a headline basis for the year to April and 4.1 per cent on an underlying “trimmed mean” basis.

Together with a rise in US bond yields, the CPI data contributed to a sell-off in the stockmarket, with the S&P/ASX 200 index hitting a four-week low near 7600 points on Thursday.

It came as the RBA’s chief economist warned that inflation is “clearly still above the target band” after another blowout in monthly inflation data for April this week.

Speaking at the Australasian Investor Relations Association conference in Sydney on Thursday, RBA assistant governor Sarah Hunter said the monthly CPI indicator “did confirm that there’s still strength in a number of categories that we’ve seen up until this point that’s still there”.

RBA chief economist Dr Sarah Hunter during Senate estimates at Parliament House in Canberra. Picture: Martin Ollman/NCA NewsWire

“That is coming together with some of the more volatile moves as well”. The RBA board is “absolutely focused on the fact that inflation is clearly still above the target band”, Dr Hunter added.

“So clearly there’s still some strength in inflation, and that’s a key consideration for the board in their decision-making”. She said the RBA believes wages growth is “near its peak” and noted that some components of wages growth are starting to “soften”.

But the RBA board is “very watchful on both wages and productivity”, she said.

The warning on the outlook for unit labour costs from the RBA’s top economist came as the Fair Work Commission was due to announce its annual wage review decision next Monday.

Dr Hunter also said the labour market is “cooling down” and the RBA is “always mindful” of stagflation risks. In that regard, the RBA doesn’t expect an “immediate turnaround” or improvement in household spending, with some households “really struggling”, she added.

Very few economists expect another interest rate hike this cycle, as consumer sentiment remains very weak and business sentiment conditions have retreated after rapid interest rate hikes.

However, Deutsche Bank chief economist Phil Odonaghoe said Australia’s waning disinflation performance could yet lead the RBA to pull the trigger on another rate hike, even as he expects the RBA to hold its fire while monitoring the impact of looming tax cuts and award wage decisions.

A rate hike decision at the RBA board meeting in August was a “material possibility” after stronger than expected inflation data for April, but like many economists, Odonaghoe stuck with his forecast of a rate cut in November amid expectations of a material weakening in the jobs market.

A 0.7 per cent month-on-month rise in the monthly CPI indicator for April was the second-strongest read for the month of April over the seven-year period for which data are available.

Australia was also the only country among peer economies where core inflation accelerated since December. In six of Australia’s peer economies monitored by Deutsche, core inflation has fallen by an average of 0.7 percentage points, Odonaghoe noted.

In his view, the RBA’s inflation forecasts for the current quarter are “at risk of being wrong again.”

“There is now a heightened risk that the RBA’s trimmed mean forecast of 0.8 per cent on-quarter for the June quarter will again prove too low, especially with key service prices in the household, medical, transport and recreation categories due in the May print,” he said.

GSFM investment strategist Stephen Miller said some of the CPI increase relative to expectations was due to rounding and revisions, as well as a surprise inclusion of health insurance premium increase in the April monthly indicator.

“There is a case to be made that the numbers aren’t as bad as they appear at first glance,” he said.

“The seasonally adjusted month-on-month increase was 0.2 per cent, which isn’t that worrying, but that may just be offsetting higher reads in March and February.”

An extended pause in any policy rate adjustment was the most likely scenario until the RBA was convinced that its current trajectory for the return of inflation to target is secure.

But that may mean any rate cuts won’t come until sometime in the first half of 2025.

“Moreover, if the timely return of inflation to target proves elusive so that the RBA misses its June quarter trimmed-mean projection of 3.8 per cent, there may well be a policy rate hike,” he said.

“A sharper than anticipated slowdown resulting in a greater-than-anticipated dislocation in the labour market may change that calculus, but despite languid growth in economic activity and my fears around the fragility of the labour market, there is little sign of that occurring.

“The reality is that those of us who were not long ago anticipating a policy rate reduction this year may have to cool their heels for a while yet. So might a government that heretofore had been anxiously anticipating a pre-election policy rate decline.”