RBA Preview: Summer Hawkishness to Continue, as Expected

Summary

• Bloomberg consensus is leaning toward a Reserve Bank of Australia (RBA) hike while the market is pushing for a pause. There are merits for both.
• Core and services inflation remains strong, despite strong disinflation in the headline.
• The labour market tightened in May, following weakness in April. However, it only brought employment back in line with RBA forecasts, while Deputy Governor Bullock’s comments on the topic were dovish.
• Survey data confirms softer demand but hiccups in services inflation progression.

Market Implications

• FX: Positioning for a hike is best done by being long AUD/NZD.
• Rates: There is little value in chasing yields higher over the summer. Instead, we want to find entry to receive AUD 2Y OIS into year-end.

Why Risks Remain for Another RBA Hike

Less than a month ago, the RBA hiked the policy rate by 25bp to 4.1% at the June 2023 meeting. At that stage, we warned the RBA were likely to remain hawkish over the summer with data unlikely to provide a reprieve over the period – the value fading that strength in the latter months of the year. Since then, hard data releases have done little to change the tune, though survey releases have proven more dovish. Overall, the RBA may well hike next week.

Strong Core and Services Inflation Continues

Core and services inflation details looked strong. Stripping out fruit and veg, transport and holiday travel (what the RBA have had their eyes on), inflation rose +0.5% MoM. It leaves annualized three-month momentum at +5.2%, down from +5.5% but way above target (Chart 1). And focusing on services, any disinflation in housing CPI (May: +8.4% YoY; April: +8.9% YoY) brought forward by lower house prices (disinflation may slow later this year) has battled against higher rents (+0.8% MoM), with signs of disinflation stalling in the former (Chart 2). Meanwhile, meals out and takeaway food increased to +7.7% YoY in May from +7.3% in April as ‘higher costs of ingredients, rents, utilities, and wages were passed on’, according to the ABS. Finance and insurance (+1.2% MoM) continues to see large rises, too.

Therefore, the only real dovish outturn can be found in the headline number where base effects helped YoY CPI (+5.6% YoY) fall past market expectations (+6.1% YoY); fuel prices fell 6.7% MoM in May vs +11.0% a year ago and volatile package holiday prices slipped 11.3% MoM.

Inflation presents a case for another hike.

Tight Labour Force but With a Couple Dovish Caveat

The labour market is tight. Employment jumped +75.9k through May (FT: +61.7k; PT: +14.3k) after a contraction in April (-4.0k), unemployment slipped to 3.6% from 3.7%, while participation crept 0.2pp higher to 66.9%. As has been usual, weak employment moves were followed by strong ones (Charts 3). Importantly, growth in employment has now stabilised, rather than contracting (Chart 4).

However, the May data comes with two caveats:

1. It only brings unemployment back in line with forecasts over the period (Chart 5).
2. Deputy Governor Bullock cautioned reading too much into volatile monthly labour force numbers in her 20 June speech.

Overall, the labour force presents arguments for a hike and a pause.

Survey Outturns Suggest Slower Growth but Stronger Services Inflation

The NAB Business Survey and flash PMI revealed moderating demand but still strong (services) inflationary pressures.

Within the NAB Business Survey, business conditions fell while business confidence returned negative – the spread between the two is now converging and trending weaker. Meanwhile, forward orders have turned negative (they correlate well with retail sales), and employment expectations slipped lower, though they remained positive (Charts 6, 7, and 8). A similar sentiment was shared in the June flash PMI; most of the activity indicators have proven softer in June with manufacturing production at its lowest since February and a services sector continuing to slow (Chart 9).

Prices ticked higher alongside purchase costs in the NAB Business Survey (Chart 10). And while this has usually been pared in the following month as prices trend lower, the better breakdown given in the June flash PMI revealed the services sector continuing to see intensified inflationary pressures with PMI contributors linking rising prices to higher interest rates, wages and energy costs. For balance of argument, manufacturing price pressures abated with selling prices easing to a 33-month low.

Another mixed outturn where some could read arguments for a pause and others could read for a hike.

Should You Trust the Economists or the Market?

Economist consensus is split 14 to 13 in favour of a hike rather than a pause (Chart 11). Meanwhile, the market is more certain of a pause, with pricing only implying a 34% chance of a hike. It is worth noting that the market has underpriced RBA hikes in 10 of the 12 hikes this cycle! If this again proves true, there should be value trading the market’s lack of conviction via AUD/NZD – it has rallied in every RBA hike this cycle when the market underpriced the hike by at least 5bps (Chart 12). The relationship fails to hold as steadily against USD or when using consensus expectations (Chart 13).

Summary and Market Implications

The RBA July meeting is a hard call with merits for both a hike and a pause. Either way, we expect the RBA to remain hawkish with forward guidance pointing toward the possibility of further hikes. Positioning for a hike can be best done by being long AUD/NZD.

Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively. 

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)