Walking the Narrow Path
The RBA Board's decision to unexpectedly increase the cash rate by 25bp to 4.10% was not predicted by most forecasters or by the market. This was surprising to many, as the RBA had previously implemented a 25bp rate rise in May and a peak rate of 3.85% was projected. Overall, the RBA's tightening cycle has been deemed incredibly aggressive by CBA due to the substantial increase in tightening that has occurred. The annual rate of inflation remains high, which is not desired, but the RBA Board intends to maintain the objective of keeping the economy balanced. However, the Board's adherence to a "narrow path" and keeping the economy stable is becoming more difficult as each rate hike is implemented.
Unique Circumstances for Monetary Policy
Monetary policy works differently in Australia than in many other countries because of the country's mortgage market. With a predominant floating rate mortgage market, the cash flow channel on the household sector is substantially more powerful for Australia. Lockdown conditions during the pandemic did affect this market, with more home borrowers opting to fix their mortgages than usual. However, the average maturity of fixed-rate loans is shorter than one would presume for most other countries and this has resulted in mortgage repayments that are high in proportion to household income. There is a significant amount of tightening predicted to occur in Australia as only half of the RBA's rate hikes have impacted borrower cash flow.
Despite having high inflation rates that have recently accelerated, the RBA Board has not increased the cash rate to the extent that is typical for most other banks. Wage growth in Australia is relatively stagnant compared to other countries, and the RBA Board is content to return inflation to its target in a more gradual manner than other central banks. The combination of these factors means that there is less pressure on the RBA Board to raise the cash rate significantly. However, there is still concern over the service sector because inflation remains persistent, which could be an unwelcome development for Australia's economy.
The RBA's Current Concerns
The RBA Board appears to be troubled by the greater risks being posed to their inflation outcomes, particularly those from the service sector. There is concern that the persistent inflation that has affected other countries will also impact Australian services. Additionally, there may be an unwanted outcome in Australia's economic narrative, particularly if persistent services inflation continues. However, a slowdown in demand is expected by CBA, which is not as concerned as the RBA Board over services inflation.
The Q1 23 National Accounts
Recent data from the Q1 23 national accounts indicated that Australia's real GDP increased by only 0.2%, while annual growth fell from 2.6% to 2.3%. GDP per capita declined by 0.3% in Q1 23, which has caused concern and could potentially lead to a confirmed recession. Hausaehold spending saw a weak quarterly result during the first quarter, recording only a 0.2% increase. Marginal growth was noted in essential spending, while spending on nonessential items decreased by 1.0%. It is possible that the recent lift in home prices could stimulate a wealth effect, which might result in a higher level of household consumption.
Our Updated RBA Call
Although there is much that remains unclear as of current, CBA economists have revised their outlook for Australia's interest rates. Based on their updated findings, they predict that there will be a further 25bp increase in the cash rate, reaching a peak of 4.35%. This rate is expected to be implemented during the August Board meeting, though there is also a risk of the cash rate rising by 25bp in both July and August. Policy easing of 125bp is expected in 2024, with rate cuts predicted in Q1 24 and additional rate cuts scheduled for Q2 24, Q3 24, and Q4 24.
