David Bassanese
2 minutes reading time
The RBA lifted rates only 25bps yesterday, as widely expected, despite last week’s high CPI.
The RBA clearly indicated it will still likely raise rates in coming months. The question is how far?
Note recent RBA inflation forecasts have been based on market assumptions with regard to the future path of the cash rate. As recently as the August Statement on Monetary Policy, the RBA forecast that annual trimmed mean (“underlying”) inflation would still be at the top end of its target band until at least end-2024. In yesterday’s statement, the RBA is still forecasting inflation above 3% over 2024.
It begs the question: is or should the RBA be happy with these inflation projections? Is allowing inflation to remain above 3% for at least three years (2022 to 2024) consistent with its mandate to keep inflation within the 2 to 3% target band “on average, over time”. Does this risk entrenching higher inflation through a lift in inflation expectations?
If the RBA is unhappy, it likely means it’s planning to raise rates by more than the market currently expects. If the RBA is happy, it begs the question whether it should be – given, as noted above, its implies several years of inflation above its target band.
My answer is that the RBA is likely happy with these projections (and hence market pricing of a cash rate peaking at 3.5 to 4%) provided two conditions remain in place, namely
- Wage growth does not accelerate too rapidly in coming quarters given still low unemployment;
- Longer-run inflation expectations – as broadly measured across households, business and financial markets – remain broadly within the RBA’s 2 to 3% target band.
In short, provided wage growth and inflation expectations remain contained, the RBA likely feels it can afford to be patient in waiting for inflation to slow – with ideally only a soft landing rather than recession for the economy.
Of course, global developments also pose downside interest rate risks – if a global recession also pushes Australia closer to recession – then the RBA would likely be inclined to raise rates by much less than currently expected by financial markets, and could even cut interest rates later next year.
My base view is that the US economy will go into recession in 2023, which will limit the degree to which the RBA raises rates further. My base case expectation is three further 25pbs moves in December, February and March and a peak cash rate of 3.6%. A US recession – and rising local unemployment – could then see the RBA cut rates by, say 50bps, in the second half of 2023.
