WEEKLY E-MAIL

5 August 2022

RBA INCREASES RATES BY ANOTHER 0.50% WITH MORE TO COME

By Paul Nicol

As expected, the Reserve Bank of Australia (RBA) Board increased the cash rate by 0.50% to 1.85% earlier this week, continuing the most aggressive pace of monetary policy tightening since 1994. Another 0.50% hike in expected September before the pace of tightening slows, with a cash rate of 2.85% anticipated by year-end. After that, rates are expected to peak at 3.10% by early 2023.

In recent weeks, markets have significantly rewound the degree of expected RBA rate hikes. The market is now anticipating a cash rate peak of a little more than 3%, in part reflecting that high inflation is more or less priced in, and markets are shifting their focus now to the potential downside risks to the global growth outlook. Markets are now anticipating that central banks can successfully “thread the needle” and fine-tune policy tightening to the extent that they bring inflation back under control and avoid a recession. But, this will be a difficult task.

Inflation has yet to peak…

Accompanying the rate rise, the RBA has also once again raised its inflation outlook and is now forecasting a peak of 7¾% in 2022 (versus a forecast peak of 7% just two months ago). In addition, they have also slowed the path of deceleration. They do not expect inflation to fall back to 3% until 2024 (versus its previous forecast of inflation falling back towards the 2-3% range over 2023). It is clear that despite further rate hikes and pain for borrowers, Australia will have to deal with inflation that sits well above the RBA target level of 2-3% for the coming few years.

Although the market interpreted the commentary as particularly dovish, some are more cautious about the path ahead. The RBA not only expects inflation to rise further than the previous forecast but also to stay higher for much longer. The governor also made clear that the path for rates is not pre-set and that a faster pace of rate hikes cannot be ruled out. With Governor Lowe acknowledging that keeping the economy “on an even keel” will be extremely difficult, the RBA’s updated forecasts for the unemployment rate to rise to only 4% and inflation to fall to ~3% by the end of 2024 are seen as close to a Goldilocks forecast as you can get.

…and growth headwinds are building

The RBA had also downgraded its forecasts for economic growth to 3¼% over 2022 and 1¾% in 2023 and 2024 (versus 4¼% in 2022 and 2% in 2023 and 2024 previously). Although domestic data appears intact for now, with unemployment at a near 50-year low, solid business investment and household consumption still holding, growth headwinds are building and not falling – and will only increase as we get deeper into the tightening cycle. Current conditions are expected to buffer against a deep downturn rather than prevent further economic weakness.

For now, inflation has still yet to peak and policy conditions will tighten as the RBA fights to control inflation. While the labour market is tight, this is a lagging indicator, and consumers will face rising pressure, with sentiment already declining. Real incomes have already fallen ~4% from their peak (the largest fall since the early 2000s), debt servicing costs will continue to rise, and collateral values (housing) is declining. Australia’s inflation problems are lagging the world and still rising, and if Australia is set to follow the path of the US and other economies, then more pain will come.

Investment implications

The best-case scenario is that central banks can drive a small increase in unemployment, a small decline in aggregate demand, a short correction in investment spending and a moderate decline in consumer spending. There is pain to come for the real economy here in Australia before conditions begin to improve and be comfortable that risk assets have the support of policy conditions and growth momentum.

Paul Nicol

Managing Partner
Senior Financial Planner
SMSF Specialist Advisor™
Barron’s Top Financial Adviser 2017-2021
Authorised Representative No. 230876

If you have any questions or comments, please email me at paul@gfmwealth.com.au

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