MNI STATE OF PLAY: RBA To Hike 50 As Inflation Stays Priority

The Reserve Bank of Australia will tighten policy for a fifth consecutive meeting on Tuesday, with an expected 50 basis point hike pushing rates to a near eight-year high and close to Martin Place’s estimate of its “neutral” rate as it remains focused on its battle to rein in inflation.

A rise in the Official Cash Rate to 2.35% will bring it within striking distance of the RBA’s estimated neutral nominal rate of 2.5%, sharpening focus on the post-meeting statement for any signs the RBA may moderate its tightening pace over coming meetings as falling house prices and some forward indicators signal slowing growth.

There is a small risk of a 40-basis-point rise should the RBA seek to return the cash rate changes to traditional increments.

The RBA is likely to underscore that its monetary policy outlook remains data dependent by reiterating it is “not on a pre-set path”, but its “high priority” of returning inflation to its 2%-3% target has futures markets pricing in a terminal rate of just over 3% as it continues on its most aggressive tightening cycle since 1994. The Bank’s Statement of Monetary Policy forecasts inflation peaking at 7.75% by the end of the year.

The RBA’s policy considerations – and market pricing of them - follow in the wake of a bluntly hawkish warning from Federal Reserve Chair Jerome Powell of “forceful and rapid steps” to moderate demand. (See MNI INTERVIEW: Powell Channels Volcker To Head Off '80s Redux)

Tuesday’s board meeting heralds a blockbuster week for Australia economy watchers, with second quarter GDP released on Wednesday and a speech by Governor Philip Lowe on “Inflation and the Monetary Policy Framework” on Thursday, which may yield additional insight into the bank’s policy trajectory.

While the 175 basis points in tightening so far in this cycle has not been reflected in key economic data such as the unemployment rate and consumer price inflation, which printed at a headline annual rate of 6.1 per cent in the second quarter, there are a range of indicators that show higher rates are starting to bite and complicating the bank’s ambition to keep the economy on an “even keel”.

HOUSE PRICES PRESSURED

The most visible impact of the RBA’s monetary policy normalisation has been on Australia’s AUD10 trillion housing market.

CoreLogic’s national Home Value Index fell 1.6 per cent in August, indicating the biggest month-on-month decline in housing values since 1983. There have been four consecutive months of decline since the RBA first raised rates in May. New lending for housing and building approvals have weakened.

Market expectations for house prices have broadly coalesced around the RBA’s observation in its April Financial Stability Review that a 200-basis-point increase in rates would lower prices by 15%. While a significant proportion of fixed rate mortgages inked at lower rates mature in late 2023, the RBA believes most mortgage holders overall have sufficient buffers to handle higher rates.

A better-than-expected 1.3% jump in July retail sales, in part due to higher prices, suggests consumers are still hitting restaurants and pubs despite rising mortgage rates, though the August Westpac-Melbourne Institute consumer sentiment index printed at recessionary levels.

Labour market data has been mixed. Jobs fell 40,900 in July, though a drop in the participation rate pushed unemployment to a 48-year low of 3.4%. The RBA had previously concentrated on wages growth and there are bittersweet signs for the now inflation-focused Bank that wage gains may be gathering momentum: the NAB Business Survey’s wages bill question hit a record high in July.