RBA rate cuts hopes fade but hikes expectations ‘excessive’, economists warn

Hopes of RBA interest rate cuts are fading rapidly, but it looks like markets have jumped the gun in pricing in another hike.

Analysts expect the RBA led by Michele Bullock to hold rates over the next six months given the economy is still contracting. Picture: NCA NewsWire / Jeremy Piper

Hopes of interest rate cuts in Australia are fading rapidly as inflation proves remarkably sticky as it has done overseas, but market pricing of another rate hike in looks “excessive”, economists warn.

All four of the nation’s major banks now see the Reserve Bank keeping its cash rate target unchanged at a 12-year high of 4.35 per cent until November and just one cut this year.

CBA was the latest of the big four banks to pare back forecasts of interest rate cuts this year after previously calling for three rate cuts in the wake of higher than expected inflation data last week.

While jobs growth has remained solid since the pandemic, an unexpected slump in retail sales last month - despite price increases and massive population growth - was the latest sign that households are been squeezed by the soaring cost of living including. That includes a sharp increase in interest payments after the pandemic-era outbreak of inflation triggered the fastest rate hikes in decades.

Nominal retail sales fell 0.4 per cent on-month versus a 0.2 per cent rise expected. Underlying retail turnover has been flat for the past six months and rose just 0.8 per cent on year.

Retail spending remains a concern.. Picture: NCA Newswire / Gaye Gerard

Apart from the pandemic period and start of the GST it was the weakest growth on record.

After March quarter inflation data exceeded estimates last week the Reserve Bank board is expected to repeat the line that it’s “not ruling anything in or out” on monetary policy and possibly even revert back to an explicit tightening bias after its meeting next Tuesday.

After March quarter inflation data exceeded estimates last week the Reserve Bank board is expected to repeat the line that it’s “not ruling anything in or out” on monetary policy and possibly even revert back to an explicit tightening bias after its meeting next Tuesday.

Waning hope of interest rate relief is set to weigh on consumer sentiment, already near its lowest levels recorded outside of recession. Focus then turns to the Federal Budget and “Stage 3” tax cuts.

CBA expects the RBA to be on hold over the next six months given the economy is still contracting on a per capita basis, inflation is forecast to fall further and the labour market is anticipated to loosen.

But near‑term risk now sits with an interest rate hike, according to CBA’s head of Australian economics, Gareth Aird. He says incredibly strong net overseas immigration has put upward pressure on some price categories, making the RBA’s task of returning inflation to target more difficult.

As a consequence, monetary policy is now likely to stay at a restrictive setting for longer.

Leading the hawkish barrage, Capital Economics expects the RBA to hike the cash rate target by 25 basis points to 4.6 per cent at its meeting next week. That would surely trigger another round of mortgage rate increases, adding to mortgage stress and potentially hitting the labour market.

“Given the RBA’s ostensible resolve to return inflation to target within a reasonable timeframe, it can ill afford to look past the upside surprises in the latest CPI and labour market data,” said Capital Economics economist Abhijit Surya.

He doesn’t see the RBA cutting until early 2025.

But recent money market pricing of a roughly 50 per cent chance of another rate hike by the RBA over the next six months was “excessive’, according to Deutsche Bank macro strategist, Tim Baker.

Unlike the US, Australia’s inflation rate is still trending lower in six-month ended terms and some measures of underlying inflation are back inside the 2-3 per cent target band, although he slower pace of disinflation in the March quarter was “worrying.”

Meanwhile G10 peers are generally still priced for rate cuts, yet several of them have higher inflation than Australia. “Simply, the RBA looks very mispriced to us,” Baker said.

He sees a strong relationship throughout much of the G10 countries between the current inflation overshoot and how much in terms of rate cuts is priced in for the next six months.

Norway and NZ still have high inflation – more than Australia – and are priced to cut only slightly.

The euro area and Sweden have an inflation overshooting their respective central bank targets by less than 100b basis points and are consequently priced to cut by at least 50 basis points.

“The US is an understandable exception to this trend given its growth and inflation profile, but oddly Australia is an even larger outlier,” Baker said.

If Australia converged to the trend, the RBA would be priced for at least 30 basis points of cuts.

Still the RBA may sound a bit more hawkish which could keep hike pricing intact for now.