The Reserve Bank of Australia (RBA) has been gradually making room for itself to tighten in the coming months. But much higher-than-expected inflation in 1Q22 means a May hike is in the frame, and there is a good argument for some front-loading too in subsequent meetings. Any positive impact on AUD may be offset by a challenging external environment
Inflation has been on everyone’s mind since the Russian invasion of Ukraine resulted in a massive global supply shock across multiple axes – energy obviously, but also agriculture and metals.
If there is one economy in the Asia Pacific region that comes out of this better than any other, it is Australia – a major net producer across all the commodity lines affected.
Australia’s trade surplus remains very strong, helped by this massive positive terms-of-trade shift, and the supply disruptions that have given rise to this shock look likely to remain in place for the foreseeable future, with little sign of a potential peace breakthrough any time soon.
Australia’s unemployment rate is already at a record low rate of just 4.0% and though we won’t get 1Q GDP numbers until early June, the growth picture looks to be holding up well if PMI numbers can be relied on. And that positive conclusion comes despite the obvious problems that China is having thanks to its zero covid policy and earlier regulatory blitz.
With 1Q22 CPI inflation coming in at 5.1%, and the core measures favoured by the RBA all coming in above the top of the upper band of the target range, the arguments for a rate hike are looking stronger now than ever.
All the hurdles the RBA has previously placed in front of any rate hikes are arguably already met. The main bone of contention was that they have previously argued that for the inflation we are seeing to be “sustained” and therefore needing a policy response, there had to be a wage element. And the line in the sand that had previously been set was a wage-price inflation rate of 3.0% year on year. This wage data is released quarterly, and we won’t get 1Q22 data until 18 May. In other words, not until after the forthcoming 3 May RBA rate-setting meeting.
It was previously anticipated that the 3 May RBA meeting would lay the groundwork for a June hike but leave policy rates unchanged. The wage price index would subsequently be released, and although it may not have reached the 3% threshold, it would be close enough to enable the RBA to say that all the conditions for hiking rates had been met. And then at the 7 June RBA meeting, the bank would finally hike rates by 40bp taking the cash rate to 0.5% and lifting the Exchange Settlement (ES) rate by more than that to help push the cash rate closer to the target rate.
The US Fed’sown anticipated aggressive front-loading will still leave the RBA on the dovish side of the Fed. And the AUD’s recent weakness also adds some additional policy flexibility that might otherwise have been viewed as problematic.
The market until very recently had seemed to be pricing in way too much tightening over much too short a time frame. It has done this since the beginning of the year, long before the Russian invasion of Ukraine or the subsequent commodity price surge.
Following the latest inflation shock, the market is now pricing in an implied yield on the December 2022 3m bank bill future of 2.8%.
The cash rate will rise to 0.5% next week, and then rise a further 50bp in June, and then by a further 25bp at every meeting until the end of the year.
The 3.6% implied rate for end-2023 only assumes a further couple of rate hikes in 2023. It is still probably a bit higher than comfortable levels, but it is no longer looking totally ridiculous.
