RBA Preview: RBA to Hike to 3.10%, Downside to 2023 Expectations

Summary

• We expect another 25bps hike to 3.10% at the Reserve Bank of Australia’s (RBA) 6 December policy meeting. Since the last meeting in early November, inflation has remained way above target. And while it appears to have peaked, the RBA will likely want to see more evidence that the disinflation process has set in before slowing the hiking cycle.
• Australia’s labour market remains exceptionally tight; unemployment is the lowest in 50 years while wage growth has surpassed 3% for the first time since Q1 2013.
• Our indices for Australian inflation, unemployment and wage growth show that the peak inflationary pressures have passed. That is, at ~3.7/3.8% the market is implying too high of a terminal rate for the RBA.

Market Implications

• The Australian futures curve looks too steep.

What Happened at the Last Meeting?

The RBA hiked the cash rate by 25bp to 2.85% at its November meeting, as expected. A 25bp hike was not a foregone conclusion, however; markets had assigned a 20% chance of the Bank returning to 50bp hikes.

In the statement, the RBA reiterated much of the same themes as before: aiming for a soft landing, and unemployment expected to remain around record lows for 2022 and increase gradually to 4% by 2024. They also updated their inflation forecast to peak at 8% later this year.

There were a few interesting points in the speech, too. Notably, the Board discussed leaving rates unchanged. This was more to tame market pricing than anything which had implied a 4%+ terminal rate. Governor Phillip Lowe also noted that they are prepared to hike by 50bp if needed. We see this as unlikely – it would have to come after a strong Q4 print (recall, they ‘officially’ care about quarterly inflation, not their new monthly figure) which would mean a 50bp hike in February. This would be with a 3.1% cash rate assuming we get 25bps next week. This seems unlikely.

Price Pressures Peaking

Australian Inflation is About to Peak

Inflation has been rampant, but it is about to peak. It has in some instances. Our Australia inflation index¹ indicates it is time for it to turn there, too (Chart 1). Indeed, CPI increased +6.9% YoY through October, smaller than the increase in September (+7.3%) and a smaller increase than markets had expected (+7.6%). However, we warn that risks remain to the upside, in line with RBA forecasts (Chart 2). Travel and accommodation (-6.4% MoM) prices fell sharply during October – school holidays ended, and the peak tourist season passed while the component weight was increased in the annual CPI weight update – and while it tends to also fall in November, the past three years has seen it offset by increases in December. Moreover, fruit and veg prices (-6.3% MoM) will likely reverse some of the recent decline with NSW and Victoria recently experiencing the most expensive natural disaster in Australian history.

Labour Market Tightness Has Also Peaked

Unemployment sits at 50-year lows. We think the pressure will ease soon, as our index¹ indicates (Chart 3). Migrants are returning to the country, adding to the labour supply, cyclical strength in the labour force is easing from Covid-19 peaks, and the applications per job ad ratio is rising (Charts 4, 5 and 6).

No Evidence of a Wage-Price Spiral

Wage growth has risen around the globe, but not in Australia. In Q3, it crept above 3% for the first time since Q1-2013 (Q3 2022: +3.1% YoY) but partly due to larger bonuses than usual (to offset the need for higher salaries; Chart 7 and Table 1). Public wages – the stickier component of the wage growth number – saw higher-than-normal wages increase on the back of a big lift in the Annual Wage Review (c.4.6-5.2%). The RBA forecasts wages to increase by 3.7% YoY in H1 2023 before peaking at 3.9% in H2 2023. Our index (which leads the official figure by six months) shows the RBA might be right. More evidence is needed to conclude how sustainable the peak in wage growth will be (Chart 8).

RBA Outlook

The RBA has alluded that a pause could come during the hiking cycle. We think the markets are misinterpreting this – they are stuck between a pause and a 25bp hike – and that it will not come in December. In short, while our indices show labour market and inflationary pressures are set to ease, we believe the pressure is not off just yet. We continue to expect a 25bp hike in December taking the cash rate to 3.1%.

Further ahead, we have long disagreed with the market-implied terminal rate above 3.8% and see a terminal rate below 3.60%. Thus, we believe the Australian futures curve is too steep.

Footnote

[1] – This is a preliminary index and has not been subject to statistical scrutiny. The composition is likely to change.

Ben Ford is a Researcher at Macro Hive. Ben 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.

(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.)