Economic and Financial Market Update: One step closer to the peak

Summary:

• The RBA increased the cash rate by 0.25% at its November meeting;
• The cash rate is now 2.85%, the highest level in over 9 years;
• The RBA change in forecasts acknowledges a difficult trade-off with inflation revised up and GDP down;
• Another 0.25% point hike is highly likely in December.

What the RBA did 

As generally expected, the RBA hiked rates by 0.25 percentage points following its November Board meeting. The cash rate currently stands at 2.85%, the highest level in over nine years. The RBA modestly revised up its inflation forecasts for both 2023 and 2024 (by about half a percentage point in both years). They also reduced their GDP growth views by a tick. The unemployment rate is projected to stay around its current level until the end of next year before modestly rising to 4% in 2024 (the same forecast as in August). These appear to be reasonable forecasts.

The RBA acknowledges the difficult trade-off. Inflation continues to surprise to the high side, while forecasts for economic growth continue to be revised down. The global economy and household spending (negative real wages, impact of higher rates) were nominated as the two big risks. The RBA explicitly stated that further rate hikes should be expected. It looks probable that we can ‘look forward’ to another 0.25 percentage point rise in December. 

The immediate financial market reaction was bond yields and the $A fell. This reflected some chance of a 0.5 percentage point move by the RBA. At the time of writing, financial markets were still pricing in a peak cash rate of this cycle of around 4%. 

From here attention will now shift to the US Federal Reserve November meeting. The result will be particularly important for the immediate future of the $A. The focus of the Fed meeting will not be so much ‘how much’ interest rates change (0.75 percentage point rise is essentially locked in), but how many more additional rate rises might come. Given the uncertainties about the inflation and economic outlook, it is unlikely that financial markets will get an immediate answer.

Inflation outlook

The cash rate is now back at what the RBA believes is a more ‘normal’ level of interest rates. The main focus is what level of the cash rate will be necessary to get inflation back to the RBA’s target. On face value the current level of inflation is a concern. The headline inflation rate is at its fastest pace in over thirty years and over twenty years for the RBA’s preferred measure of ‘underlying’ inflation. A fair bit of the rise of inflation can be put down to international factors (post pandemic supply chain worries, wars, bad weather). However, non-tradeable inflation (price rises reflecting domestic factors), have also been rising strongly (the floods have played a role).

The super-charge demand boost is still influencing the growth of goods prices (as well as the impact of the weather and war). But service prices are also on the rise, and they tend to be more influenced by domestic factors (notably wages growth). Price rises are widespread. A very small percentage of goods and services bought by households are falling, and only 15% are rising by less than 2%. By contrast, almost 80% of goods and services are rising by over 3%. Australia’s inflation rate is looking very similar to that of comparable countries.

To read my full update, click here.

We live in interesting times.

Regards,

Peter Munckton - Chief Economist