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Interest Rate Update: Nearing the peak of Table Mountain

05 December 2023

Summary:

The RBA kept the cash rate unchanged at 4.35% following its December meeting;
This decision was widely expected;
The RBA retains a bias towards higher interest rates;
Developments in inflation, the jobs market and global interest rates will play an important role in the outlook for our cash rate.

RBA announcement

The RBA kept the cash rate at 4.35% followings its December meeting. The decision was widely expected. The data on economic activity has been mixed over the past month while the inflation news has been good (i.e., it is heading lower). Given that backdrop and the knowledge that the full impact of past rate hikes has yet to hit the economy, the decision to keep the cash rate unchanged was straight forward.

The outlook part of the statement released following the decision was unchanged. If there is to be any move in interest rates for at least the next 3-6 months, it will be up. That is in line with current financial market pricing. Financial markets have rate cuts in Australia priced to occur later than in peer economies. That also makes sense given that the cash rate is currently lower in Australia.

Drivers of the interest rate outlook

In my view there will be three main drivers of the interest rate outlook for the next year: the path of inflation, what is happening in the jobs market and movements in the global cash rate.

Inflation is moderating. While the most recent update had the annual inflation rate at a tick under 5%, my read is that the inflation run rate is currently somewhere between 3-4%. Business surveys are consistent with moderating price growth. Alternative measures of inflation (such as the Melbourne Institute monthly index) suggests that inflation is already near the RBA’s target band. Consumer inflation expectations though are still a bit high.

The key issue is that RBA forecasts only have inflation returning to the 2-3% target band by the end of 2025, and that we will only just be scraping into the band by that time. It is my belief that it has been the extended period outside the inflation target band that has been the major factor influencing financial market medium-term inflation expectations. That is why the RBA is so focused on ensuring that inflation is still not above 3% by end-2025.