MNI INSIGHT: 75 Basis Points Hike Unlikely For RBA

With another interest rate hike from the Reserve Bank of Australia at next week’s meeting widely expected, MNI understands an increase of either 25 or 50 basis points is more likely than a larger 75 basis point hike even with inflation a growing worry.

The RBA’s view is that because it meets monthly, it can better respond to fresh economic data with smaller rate rises, and that larger increases such as the 75 basis point rise by the US Federal Reserve are not currently warranted in the Australian context.

The RBA has abandoned forward guidance and the forecasts made in the May Statement on Monetary Policy and now says it is guided by shorter term data independent of market expectations, (See: MNI STATE OF PLAY: RBA Turns Hawk In Biggest Hike Since 2000).

The bank has also conceded that its response to the pandemic, where it provided what it saw as maximum insurance through cutting rates and buying government bonds, was based on a worst case scenario which didn’t play out. This had led to a strong recovery in demand which had created the supply side issues which are driving inflation now.

While it is working with the Australian Bureau of Statistics on monthly inflation reporting to be delivered in future, the central bank is also limited by quarterly inflation data which will not be reported until July in time for the August meeting.

INFLATION, WAGES

CPI inflation in the first quarter was at 5.1% while underlying inflation – the bank’s preferred measure – was at 3.7%. The RBA has an inflation target of 2 to 3% and RBA Governor Philip Lowe said he expected CPI inflation to reach almost 7% in the last quarter of this year before declining.

Lowe said the bank is prepared to “do what it takes” to get inflation down, and MNI understands the bank’s view on wages growth is also changing as a result of inflation, (See: MNI INSIGHT: RBA Now Data Driven As Guidance Suspended).

For much of the last two years, the bank has said that wages growth needs to increase to take inflation into the target range, but now the view is that at any more than 3.5% wages growth will be inflationary.

ECONOMY OUTLOOK

First quarter wages growth was at 2.4%, but the bank cited later data from its liaison program in its May decision to raise rates by 25 basis points from the record low of 0.10%. Since then, the Fair Work Commission has increased the minimum wage by 5.2% and minimum award wages by 4.6%.

The RBA still believes that the Australian economy is resilient and can avoid recession, but is using similar language to other central banks, saying that it is still on a “narrow path” back to low inflation without tipping the economy into recession.

At this point, MNI understands that the RBA does not believe it needs to match the US Fed in its hawkishness, and that the central bank is also sanguine about the weakening dollar – which has fallen from US76 cents to US$69 cents in the last 12 months - even though a higher dollar would help counter inflation.

While the AUD has fallen against the USD, the RBA points out that it has maintained its value in the Trade Weighted Index.