Australia | Apr 05 2023
The RBA has delivered a pause in rate hikes not unsurprisingly, but most economists agree there will need to be one or more hikes down the track.
-RBA pauses to assess
-Risk remains of a wage-price spiral
-Economist outlooks for policy vary significantly
-Upcoming CPI data critical
By Greg Peel
After ten consecutive rate hikes from a cash rate of 0.1% to 3.60% over just twelve months, the RBA has decided to pause to assess the impact. This is not a surprise as rhetoric post the March meeting had hinted at the possibility, and economist assumptions were leaning more towards a pause than another hike.
The two elements within yesterday’s decision that point to a more dovish RBA from a month ago are the pause itself and a subtle change in statement language.
In March, following the last 25 point hike, the RBA noted “further tightening of monetary policy will be needed”. In April, this was changed to “further tightening of monetary policy may well be needed”.
The pause was needed to provide “more time to assess the state of the economy and the outlook, in an environment of considerable uncertainty.” The board “recognises that monetary policy operates with a lag and that the full effect of this substantial increase in interest rates is yet to be felt”.
This was a new statement observation, albeit noted in prior rhetoric. Jarden estimates that to date, 70% of the impact of rate hikes has been felt, which will rise to 83% by June assuming no further hikes. The greatest impact will be felt when standard variable mortgage rates catch up, amidst stiff bank competition, and earlier fixed rates on mortgages mature – the bulk set to do so in the next six months.
The statement noted that "While some households have substantial savings buffers, others are experiencing a painful squeeze on their finances". And that’s before the so-called mortgage cliff.
“There is further evidence that the combination of higher interest rates, cost of living pressures and a decline in housing prices is leading to a substantial slowing in household spending.”
“Substantial” seems to Morgan Stanley to be more “outsized” a comment than the most recent retail sales data would suggest. Retail sales grew 0.2% in February, albeit down from 1.8% in the January post-covid summer spending spree. Morgan Stanley suspects the RBA may have feedback from other sources other than just the ABS data to make this claim.
And netting out for inflation, the February sales result implies sales volumes fell.
Inflation
The RBA’s rock-and-a-hard-place problem is that while the risk is rate hikes to date may tip the economy into recession, there is a greater risk inflation will begin to run away again if policy is not tightened further.
Jarden views an RBA pause at this point as risking another “dovish mistake” given upside risk to underlying inflation. “Another” is a reference to Philp Lowe’s now infamous assertion in 2021 that there is no chance of a rate hike until 2024.
With inflation expected to remain materially above target for another four-plus years, Jarden believes the RBA's current forecasts imply a material risk of entrenched inflation – albeit it does follow five-plus years of entrenched below target inflation. Indeed, the RBA's approach is markedly different to global peers who are focused on returning inflation to target over shorter time frames.
While Jarden agrees normalising supply chains and softer demand will see goods inflation moderate, the broker is not alone in expecting services inflation to remain stubbornly high, particularly given large increases in rents, insurance, utilities, groceries and council rates.
Labour
The board retains an outlook as noted in March that “wages growth is still consistent with the inflation target” but has now added the caveat “provided that productivity picks up”. Accordingly, the board “remains alert to the risk of a prices-wages spiral”.
Citi suspects this comment relates to the possibility the long-run neutral rate will be higher without a sustained increase in productivity rather than a near-term threat to the cash rate target.
Credit Suisse continues to see solid evidence for labour market growth which underpins the economists’ thesis for the “circularity of income”. This is an economic model suggesting how an economy works: if you want to pay for goods and services, you need to exchange money for them. And to pay for what you want, you need to earn income.
Household incomes are expanding at both the price and the volume of labour, Credit Suisse notes. Presently strong levels of income growth continue to underpin household spending and inflation.
It is hoped the resurgence of migration will serve as a relief valve for labour market tightness and upside pressure on wages. But the Albanese government is not helping. The May budget will no doubt deliver on a policy Labor went to this year’s election on – reducing cost of living pressures.
The upcoming Fair Work Commission wage decision is likely to lead to an increase in the minimum wage. Note that that minimum wage is the base from which all wages are set by the government, hence an increase in the minimum leads to a ratchetting up of all award wages.
There may also be relief provided on power bills.
And deservedly or not, the new Labor government in NSW has pledged to lift the prior cap on wages for nurses, teachers, aged care workers and so forth.
Fiscal policy is operating counter to monetary policy intentions.
What does consensus suggest from here?
They say that if you laid every economist end to end they still wouldn’t reach a conclusion. The consensus view is there isn’t one.
Provided domestic demand continues to cool, Citi believes the RBA should keep the cash rate target at 3.60% this year before slowly normalising (ie cutting) from the March quarter 2024. But Citi qualifies its stance in suggesting “Although our official view is that the RBA will keep rates unchanged until Q1 2024, we still believe that risks are tilted towards another 25bp hike”
Citi’s economists are not the only ones to point out the potentially counterproductive impact of the RBA’s pause. Consumer sentiment has been under pressure for a year on each successive rate hike. A pause represents blessed relief, hence the risk is those households not under extreme pressure will feel safe to go out and start spending again.
This is no doubt why the RBA has qualified its pause with the warning rates may well need to rise again.
Morgan Stanley had expected an April hike but believes the RBA's period of assessment is consistent with “at least a few months on hold”. Morgan Stanley agrees with the RBA that further tightening will likely be needed.
Westpac’s economists had expected an April pause, but “while the Board’s tightening bias has been softened in parts, in the April decision statement, there is not sufficient evidence for Westpac to change its forecast that the Board will make one last 0.25ppt increase in the cash rate at the May Board meeting”.
“That decision will be in the context of underlying inflation holding well above the target level, only slowing moderately, in an economy where the unemployment rate remains near 50-year lows and dismal productivity exacerbates the eventual impact of wages growth on inflation”.
ANZ Bank economists believe inflation will prove persistent enough to require the RBA to tighten further in the months ahead. The question in ANZ’s view is not so much one of “where” the RBA gets to the terminal rate but “when” it gets there, and continues to forecast 4.10% (two more hikes).
Credit Suisse continues to see further scope for rates rises this year on the forecast of robust labour growth, especially on strong population and overseas migration. Credit Suisse’s peak terminal cash rate forecast remains at 4.60% (four more hikes).
Watch the Numbers
One thing all economists can agree on is that a “pause to assess” means the RBA is very data-dependent from here on. There are two important data releases due ahead of the May meeting.
One is next week’s March jobs numbers, but the biggie is the March quarter CPI data, due on April 26. If these suggest a meaningful drop in inflation, economists are prepared to reassess their forecasts.
News Flash
The RBNZ this morning surprised the market by hiking a full 50 points when 25 was widely expected, to “reduce inflation and inflation expectations to within the target range over the medium term”.
New Zealand’s cash rate is now 5.25%.
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