RBA: Eye Beyond Neutral

Published on July 29, 2022
SGH Insight
The Reserve Bank of Australia (RBA) will likely deliver the third in a series of 50bp moves in the cash rate to 1.85% August 2 and signal more tightening to come in the months ahead, tacking a more aggressive charge toward a restrictive policy setting beyond its 2.5% neutral estimate by year’s end...

...The pickup in the annual trimmed mean measure of core inflation, closely monitored by the Bank, could keep the prospect of at least one additional 50bp move at the September 6 or October 4 meetings alive, but probably not at both, at least not before the RBA sees another inflation report.
The next quarterly inflation reading is due October 26 and will give the Bank an opportunity to calibrate whether to move ahead with 25bp hikes at the November 1 and December 6 meetings...


Market Validation
Dow Jones 8/2/22

Trending: RBA Raises Cash Rate for Fourth Straight Month

Australia's central bank is the most mentioned entity over the past 12 hours, according to Factiva data, after it raised its benchmark cash rate target by 50 basis points to 1.85%. This marks the fourth time the Reserve Bank of Australia has raised the rate in as many months. Prior to May, the RBA hadn't raised the rate since November 2010.

Bloomberg 8/2/22

Australia’s central bank gave itself wriggle
room to adjust the pace of interest-rate increases if the
economic outlook deteriorates after delivering the sharpest
policy tightening in a generation.
“The board expects to take further steps in the process of
normalizing monetary conditions over the months ahead, but it is
not on a pre-set path,” Governor Philip Lowe said after hiking
by 50 basis-points for a third straight month to 1.85%.

The Reserve Bank of Australia (RBA) will likely deliver the third in a series of 50bp moves in the cash rate to 1.85% August 2 and signal more tightening to come in the months ahead, tacking a more aggressive charge toward a restrictive policy setting beyond its 2.5% neutral estimate by year’s end. 

The country’s latest inflation report has the RBA more determined than ever to bear down quickly on inflation by mopping up Covid-related “insurance” and to move rates to a moderately restrictive setting.

Governor Phil Lowe says left unchecked, wage and price setting behaviors risk becoming embedded at a higher level and force even higher rates that would prompt a steep recession.

“We’ve got to move away from these very low levels of interest rates we had during the emergency. We took out a lot of insurance, we have to remove the insurance, and there’s more work for us to do there, and we’ll be guided by the outlook for inflation,” Lowe said.

The latest inflation report has hardened the RBA’s resolve. Prices advanced 6.1% in the second quarter versus the same quarter a year ago, just shy of economists’ expectations, but at their fastest clip in 21 years. 

The pickup in the annual trimmed mean measure of core inflation, closely monitored by the Bank, could keep the prospect of at least one additional 50bp move at the September 6 or October 4 meetings alive, but probably not at both, at least not before the RBA sees another inflation report.

The next quarterly inflation reading is due October 26 and will give the Bank an opportunity to calibrate whether to move ahead with 25bp hikes at the November 1 and December 6 meetings. Two more 50bp hikes after Tuesday, followed by additional 25s, at each of its meetings this year would land the cash rate at a more-than-moderately restrictive 3.35% by year’s end. We think the Bank is more likely eying a cash rate just above 3%.

The trimmed mean measure rose at its fastest pace since 1991, up 4.9% in the second quarter from 3.7% in the first quarter. 

The Bank fears inflation could peak as high as near 7% by year’s end, all but guaranteeing official projections will be revised upward when the quarterly updates are released August 5. The May Statement on Monetary Policy projected inflation to at 5.6% by end 2022, and a return to the top end of the RBA’s 2-3% target band some time in 2024.

Lowe has made no secret of his resolve to chart a “credible path” for inflation back to the Bank’s 2-3% target, describing to a forum in Melbourne July 20, “a process of steadily increasing interest rates, and there’s more of that to come.”

“So the mindset we have is one of steady increases in interest rates now to forestall a persistent shift in inflation and inflation expectations,” he said. 

“And, by doing that, we can have a lower peak in interest rates and, hopefully, avoid the need for a sharp slowing in expenditure. It’s better to have a modest slowing in expenditure at a time of full employment than a sharp slowing later on when inflation is much higher.”

Of course, a steeper-than-expected retrenchment by households for example, or evidence inflation is peaking sooner and at a slower rate than the Bank currently projects over the next few months, would temper policy thinking. The Bank will be monitoring household data carefully for guidance about when to ease back to 25bp clips, or even pause over the balance of the cycle.

The RBA also has flagged that downward momentum in the housing market, a key policy transmission channel, and so it will be an important input into future deliberations.

Domain’s June 2022 Quarterly House Price Report reveals that house prices have dropped for the first time in two years across Australian capitals, as the market finally slows nationwide.

Given the RBA is looking for housing to moderate and views the sector through a lens of household indebtedness, it is notable that two-thirds of households do not have a home loan. Still, the speed and depth of a housing decline will matter to the policy equation. In that context, Lowe acknowledges that his rates prescription for inflation means navigating a “narrow” policy path to keep growth afloat and unemployment low.

Though some sentiment indicators, such as Westpac-Melbourne Institute Index of Consumer Sentiment are declining, the RBA remains confident financial buffers accumulated during the pandemic by savers, as well as the tightest labor market in almost 50 years, should help consumers weather higher rates. Westpac’s monthly index dropped 3% in July to 83.8, its lowest reading since April 2020.

Back to list