By Gareth Aird, head of Australian economics at CBA:
Key Points:
- The RBA Board today increased the cash rate target by 25bp to 3.10%, as was expected by us and most analysts.
- The RBA has implicitly signalled a willingness to pause in the tightening cycle today by noting that “the Board expects to increase interest rates further over the period ahead, but it is not on a pre-set course.”
- But the tweak in forward guidance was not as material as we anticipated and as a result we shift our risk case to our base case. We now expect one further 25bp rate hike in February 2023 for a peak in the cash rate of 3.35%.
Another 25bp rate rise – hiking bias retained and another rate hike looks more likely than not
The RBA Board today increased the cash rate target by 25bp to 3.10%, as was widely anticipated by us and most analysts. It was the eighth consecutive monthly increase in the cash rate.
The RBA have delivered a massive amount of tightening in a short space of time. The RBA’s 25bp interest rate hike today means that they have taken the cash rate up by a whopping 300bp between 4 May and 6 December – (eight meetings over seven months). And as Governor Lowe noted in his post meeting Statement “there has been a substantial cumulative increase in interest rates since May”.
The Governor referenced the October 2022 CPI when he noted that inflation is 6.9% over the year. This means that the RBA is putting some weight on the new monthly CPI indicator. And it also means that the Governor wanted to point out the annual rate of inflation has come down over the month (from 7.3%/yr in September). That said, the RBA still retains its forecast for the peak in inflation to be ~8%/yr in Q4 22.
The RBA want to keep the economy at full employment, which means they do not want the unemployment rate to rise much above 4%. This is Plan A. It is very much consistent with the notion of “keeping the economy on an even keel”. We believe that pursuing Plan A is the right objective. But as the Governor noted today, “the path to achieving the needed decline in inflation and achieving a soft landing for the economy remains a narrow one.”
The path towards achieving a soft landing for the economy gets narrower with each additional rate hike. And the task for policymakers in calibrating the tightening cycle correctly is made more difficult by the lags between changes in the cash rate and the impact on economic activity, prices and wages.
The RBA is aware of these lags. But the Governor now appears more concerned about a potential wage-price spiral. Today he noted that, “given the importance of avoiding a prices-wages spiral, the Board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead”.
The outlook
The Board has retained a tightening bias, as expected. But the Governor did not soften the key paragraph around forward guidance as much as we had anticipated. The Governor stated, “the Board expects to increase interest rates further over the period ahead, but it is not on a pre-set course. It is closely monitoring the global economy, household spending and wage and price-setting behaviour. The size and timing of future interest rate increases will continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market” (change from the November Statement in bold).
The additional words that the Board is not on a pre-set path is not new information. But placing these words in the final paragraph of the Governor’s Statement implies a greater degree of flexibility in the tightening cycle from here (i.e. it strengthens the likelihood of the RBA pausing in their tightening cycle in early 2023).
That said, we had expected the Governor would change the RBA’s forward guidance more significantly to “the Board is likely to increase interest rates further over the period ahead” or “the Board is willing to increase interest rates further over the period ahead”. Given this change was not made we have shifted our risk case to our base case and now see a peak of the cash rate of 3.35% to be reached in February 2023. The risk sits with a peak in the cash rate of 3.6%, although further tightening in 2023 is not “locked in”. We continue to look for 50bp of rate cuts in Q4 23.
