Rate Rise

The Reserve Bank surprised the market today with a lift of 50 basis points, taking the cash rate to 0.85%.
The RBA now joins the 50-point hike club along with the Federal Reserve, Bank of Canada and Reserve Bank of New Zealand. It’s the RBA’s biggest rate increase since February 2000 and only the fifth time we’ve seen a move of 50bps or more since the introduction of the cash rate target.

What prompted the big move?

The cash rate has been held too low for too long and the RBA is behind the curve. They are moving more quickly to get closer to neutral.
There wasn’t any particular economic data release you could point to — wage price index data was weaker (although they prefer their own business liaison results) and the unemployment rate at 3.9% was pretty much in line with the previous month. Economic growth was solid but no smoking gun. Inflation is now higher than expected due largely to the conflict in Ukraine and Covid-related supply disruptions. Tightness in the domestic labour market and the effect from the floods on food prices are also putting upward pressure on inflation.

Where to now?

“The size and timing of future interest rate increases will be guided by the incoming data and the Board's assessment of the outlook for inflation and the labour market,” the RBA said in their statement
“The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”
I view 50 basis points next month as more probable than 25.
Households are now dealing with rising electricity prices, rising petrol prices and higher repayments for the roughly one-third with a mortgage.
It is going to sting — particularly for households that took out a mortgage over the past year and have not built up large buffers in mortgage offset accounts. The RBA acknowledges this risk. But it also recognises average household balance sheets are in strong positions — many with solid buffers in mortgage offset accounts.

A cash rate closer to 3% by the end of the year? Market pricing is aggressive. But at the moment I wouldn’t rule anything out.

What does it mean for investors?

The questions for asset owners is: while markets are looking for another 3% of rate hikes in the next 12 months, is the economy ready for it? The RBA tried to imply the economy would be resilient. But the tide is now going out.
The first 1.5% of hikes will see belt-tightening, but probably no more. However the next 1.5% could see actual stress, especially in housing. This is an experiment the RBA hasn’t undertaken for more than a decade — and risks of a policy error are rising.