RBA UPDATE May 2022
The RBA has increased the cash rate by 0.25% to 0.35% at their May meeting.
The move was largely expected given the recent Q1 inflation print which came in higher than expected with headline inflation at 5.1% and underlying at 3.7%, noting that the RBA’s target is 2-3% underlying inflation through the cycle. The only call against a rate rise, a weak one at that, was that the RBA traditionally doesn’t move rates up or down in an election month.
A fair degree of change in the RBA’s statement versus last month caused a reasonable move across markets today. The degree of change in rhetoric was always going to be interesting in terms of a mea culpa and any forward guidance, and there was plenty of both.
KEY POINTS WERE AS FOLLOWS
- The Board agreed now was the right time to start removing stimulus
- Cash rate lift by 25% and flag of more to come
- RBA’s balance sheet to decline significantly over the next couple of years (but no selling of government bonds)
- Inflation has picked up faster than expected, largely reflecting global factors
- Supply constraints remain a problem and inflation pressures have broadened.
- A further increase in inflation is expected, but inflation will start to subside as supply-side constraints are resolved
- Inflation to settle back down at 3% by mid-2024, with rate rises a key assumption.
- Anecdotally, wage growth appears too strong and largely forced the RBA’s hand to raise at this meeting.
MARKET MOVEMENTS SAW
- Australian Equities fall
- Australian dollar rise against US dollar, off recent lows near 70c
- Australian government bond yields rising strongly yet again
- CBA, Westpac and NAB have risen rates by the full 0.25% and ANZ is expected to follow shortly.
We agree that the current emergency settings for monetary policy are illogical in that there is no longer an emergency, and that rates will move higher from here.
However, we are currently of the view that interest rate and bond markets are being far too aggressive when it comes to their expectations for rate hikes for this year and next. Whilst underlying inflation is above the RBA’s through-the-cycle target, and is expected to move higher in the short term, we believe serious considerations are being overlooked in the fixation on inflation including:
1. The main driver of recent higher inflation is supply constraints – lifting rates does not fix supply, but it does kill off demand.
2. The RBA has largely under-shot its inflation target since the GFC – i.e., inflation has run too low for many years, and some “catch-up” is required.
3. A combination of higher rates, and higher rate expectations, along with supply constraints being resolved could see inflation fall quicker than is currently expected.
4. The deflationary trends that dominated inflation pre-Covid have worsened – i.e., worsening demographics, significantly more debt, and adoption of more technology.
5. The Australian housing market, and household consumption by proxy, are very sensitive to interest rates given the predominance of variable-rate mortgages
Evolving data will largely dictate the RBA’s rate path from here.
The critical question is whether the RBA will look through as things (house prices, share market, economy, etc.) start to “break” or pause for too long and be unable to restart rate rises thereafter.
Time will tell.