MNI RBA WATCH: Board To Hold, But Mull Shift From Neutral

The Reserve Bank of Australia board looks set to hold the cash rate at 4.35% when it meets over May 6-7, with policymakers considering a shift to a more hawkish tone as they evaluate still elevated inflation and a resilient labour market alongside several softer metrics across the economy.

The market will also eye publication of the Reserve’s updated forecasts within May’s Statement of Monetary Policy, which could push out the RBA’s timeline for returning inflation back to the 2-3% target and also increase its end of year cash rate assumption. The RBA had predicted inflation back to target by late 2025, and assumed a 3.9% cash rate by December.

However, the latest CPI result has pushed out market expectations of a rate cut. The overnight index swap market had priced in about two 25 basis point cuts at the start of 2024, but has pushed out any reduction until early 2025, even pricing a 20% chance of a 25bp hike at the June meeting.

The abrupt turnaround in expectations contrasts heavily with the RBA's largely neutral tone set out when the board met in March. The Board has held the cash rate steady since November 2023.

MIXED DATA

Inflation and unemployment have both printed stronger than expected since the RBA board last met.

Australian CPI rose 3.6% y/y over Q1, down from Q4 2023’s 4.1%, but 10bp higher than the market’s expectation, while the monthly CPI indictor, released alongside the quarterly result, also increased 3.5% in March, up from 3.4% in February. (See charts)

The Reserve Bank of Australia had wanted to see inflation at 3.3% by Q2, but stickyness suggests they may need to now push out this forecast in the SoMP.

The labour market also proved resilient, rising to 3.8% in March, 10bp lower than expected. However, employment fell by 6,600, considerably more than the 10,000 jobs the market expected to be created.

Despite strong Q1 CPI, a number of other metrics have printed softer since the RBA board last met. Retail sales fell 0.4% m/m in March, more than the market’s expected 0.2% drop, while building approvals continued to fall 2.2% y/y.

FISCAL STANCE

Fiscal policy represents another key variable the RBA will need to consider before it decides future monetary policy.

The government has run two fiscally conservative budgets since it took power in 2022, however, it could choose to spend more ahead of next year’s election.

Treasurer Jim Chalmers has stated the budget will not "splash cash," but it will include some cost-of-living help, which will hit the economy alongside the already anticipated AUD107 billion tax cuts due to start July 1. The government's already proposed, yet lacking in detail, Future Made in Australia Act could also add inflationary pressure.

The government will provide greater detail when it delivers its next budget later this month.

BAKED-IN INFLATION

Some former staffers have told MNI the market and RBA could have underestimated the risk of stronger inflation, which will necessitate higher rates for longer.

The spread between the yield on 10-year Australian commonwealth government bonds and the current level of real interest rates implies higher future inflation and greater risk expectations will de-anchor from the central bank’s forecasts, MNI reported recently. (See MNI INTERVIEW: Bonds Saying RBA Underestimating Inflation)

However, the chance of future rate hikes remains slim, some economists told MNI, noting the stronger components of March's print, such as education, insurance and house rentals, were little affected by monetary policy. (See MNI: Bar Remains High For Renewed RBA Hiking – Ex-Staffers)