Interest rate hike bets fade as inflation cools

The latest inflation figures have reduced the chance of another lift in interest rates next week, but don’t preclude further hikes.

Australia’s latest inflation data lessen but don’t preclude further interest rate hikes.

After peaking at a 30-year high of 7.8 per cent in late 2022, the annual headline inflation for the June quarter fell to 6 per cent, undershooting the Reserve Bank’s forecast of 6.25 per cent.

A 0.8 per cent rise in quarterly inflation was the smallest since the September quarter of 2021.

Trimmed mean inflation fell to 5.9 per cent, slightly under the RBA’s forecast of 6 per cent.

Shares reacted positively, with the ASX 200 index up 0.9 per cent to a five-month high of 7402. The market-implied chance of an RBA rate hike next week fell to 31 per cent from 50 per cent.

The peak cash rate implied by the market fell to 4.33 per cent from 4.5 per cent, implying one more rate hike from the current level of 4.1 per cent in the first half of 2024. But while inflation fell rapidly in the past six months, it’s still a long way above the 2-3 per cent target band, as it has been for the past two years. The RBA can’t afford to be complacent.

Although the RBA has said monetary policy is now “clearly restrictive”, a tight jobs market combined with low productivity growth means there’s still an elevated risk of a prices-wages spiral.

As it looks for evidence that it has lifted rates enough to lower inflation to its target in a reasonable time frame, the RBA will consider the strong labour market, weak productivity growth and upward pressure on wages, as well as progress on lowering inflation.

Fourteen months after the start of its aggressive interest rate hiking campaign, Australia’s unemployment rate is about 1 percentage point below the bank’s estimate of the non-accelerating inflation rate of unemployment. March quarter national accounts showed soaring unit labour costs and the Fair Work Commission delivered big increases in minimum and award wages.

“Some further tightening of monetary policy may be required to bring inflation back to target within a reasonable time frame, but this will depend on how the economy and inflation evolve,” the Reserve Bank said after its July board meeting. “In making its decisions, the board will continue to pay close attention to developments in the global economy, trends in household spending, and the forecasts for inflation and the labour market.”

Inflation has “evolved” positively, but remains unacceptably high and services inflation is “sticky”. Meanwhile, the labour market isn’t showing any clear signs of weakening and the property market is already taking off again on hopes of a peak in interest rates as well as surging immigration.

AMP head of investment strategy and chief economist, Shane Oliver, said the CPI data should be enough to see the RBA remain on hold next week, but it’s a “very close call”.

He said the RBA was still likely to be concerned by high underlying inflation, the still tight jobs market and upside risks to wages growth.

Dr Oliver revised down his forecast for the cash rate peak to 4.35 per cent from 4.6 per cent.

He noted that goods inflation continued to slow as pandemic distortions to demand and supply fade, with annual price growth falling to 5.8 per cent from a peak of 9.6 per cent.

But services inflation rose to 6.3 per cent year-on-year – the fastest since 2001 after the GST was introduced. Services prices slowed to a 0.8 per cent quarter-on-quarter rise but are likely to re-accelerate on the back of surging rent and utility prices as well as the minimum and award wage increases.

Services inflation is expect to follow goods inflation down later this year as demand cools and the labour market softens, but the resilient labour market leaves risks of higher wage demands that could feed into inflation, and there are also lingering upside risks for commodity prices.

Dr Oliver noted the breadth of Australian price increases had slowed, with “only” 54 per cent of the CPI basket having annualised price increases above 3 per cent per annum, similar to the US and below a peak of 70 per cent, but “still well above normal levels”.

Goldman Sachs Australia chief economist Andrew Boak lowered his terminal RBA rate forecast to 4.6 from 4.8 per cent.

“We acknowledge material risk that the RBA remains on hold in August, but lean slightly towards another hike given still elevated underlying and services inflation, the stronger-than-expected labour market, and the rapidly reflating housing market,” Mr Boak said. “We expect a final hike in November alongside finalisation of the Statement on the Conduct of Monetary Policy – which we expect will effectively require the RBA to target a lower inflation target … that is, 2.5 per cent, rather than allowing the top of the 2-3 per cent target band.”

NAB chief economist corporate and institutional banking Ivan Colhoun expects the RBA to leave rates unchanged in August on the back of the CPI outcome, while awaiting data on the evolution of the economy.

However his analysis suggests services inflation remains high and “by itself increases the risk that inflation will not return to the 3 per cent target within a reasonable time frame”, even before considering a raft of other services price increases likely in the September quarter.

Nomura Australia senior economist Andrew Ticehurst pushed out his rate hike call to November. “Despite today’s pleasant surprise, the unemployment rate remains below NAIRU, monetary policy is not appear especially tight, other central banks are still hiking and we think the RBA would be equally sensitive to any future upside inflation surprise, given the forecast protracted delay in returning inflation to the target band,” he said.

Citi economist Faraz Syed expects the RBA to hike in August and September or November.

“The bank’s underlying inflation forecasts are unlikely to be materially revised, despite some likely downward revisions to headline inflation,” he said. “(But) wages growth is expected to be upwardly revised because of the higher than expected decision on minimum wages. In our view, this justifies further rate hikes.”