They say, “hope for the best, and be prepared for the worst”.
This is the message that Lowe appeared to be sending last week to mortgage holders, telling the world that interest rates “may well” rise again.
Given the balance of risks and the outrage resulting from Lowe’s guidance that interest rates will remain low until 2024, that makes sense. Plus, inflation is still too high, and the unemployment rate is very low.
However, some of Lowe’s other comments on the economy and inflation did not sound like a governor who is ready to pull the trigger on rates again. At least not in the next few months and maybe not again in this cycle.
This sentiment was notable when Lowe was explaining why the RBA was less aggressive than its overseas peers in lifting rates, and why the RBA chose to pause lifting rates at its last meeting in April.
One reason was that mortgage rates have risen faster than in other developed economies, because of the high proportion of loans on variable rates. It was a point which I highlighted in an article I wrote for MF & Co. Asset Management last month. Lowe even presented a great chart illustrating this point:
It means de facto interest rate increases are occurring among mortgage holders, without the RBA needing to do anything more at all.
The other point that Lowe raised was a difference in the RBA’s tolerance for inflation itself in comparison to its overseas peers. In the RBA’s most recent forecasts, the RBA does not expect inflation to return to target until mid-2025. And most importantly, Lowe said that it was a “better outcome” to not try and bring inflation to target sooner at the cost of more job losses.
This comment is significant. Because even though inflation is currently too high, it suggests that as long as inflation continues on the trajectory of the RBA’s forecasts or tracks below, the RBA isn’t likely to hike again.
Of course, there has been a lot of uncertainty with regard to inflation forecasts of late. But recent indications suggest that inflation has been easing as you can see in the chart below.
What’s more, is that recent outcomes for monthly inflation suggest that there is a good chance that inflation could undershoot the RBA’s current near-term forecasts. Currently, the RBA is expecting annual inflation to hit 6.75% (underlying at 6.25%) by the end of June. Even accounting for a slight pickup in price pressures over the next few months, I would estimate that inflation could be closer to 6% by mid this year.
There is one key piece of data that would confirm (or unconfirm) this trend. That would be the March quarter inflation data released on April 26, which would be closely followed by the next RBA meeting in May.
Importantly, the RBA will also receive a set of updated forecasts at its next meeting. If the monthly trend in inflation over the past couple of months is reflected in the quarterly data, the RBA could very well downgrade their inflation forecasts, at least in the near term.
Now, even if we did see a downgrade in inflation forecasts, a 6% annual inflation is still too high. However, Lowe has just told us that the RBA was accepting a return to the inflation target in mid-2025.
It would be hard to see the RBA decide to hike rates straight after receiving some downgraded inflation forecasts, particularly after pausing rate hikes in April.
The RBA says that a range of information will determine whether the RBA will need to lift rates again, including the labour market, business sentiment, the global economy, household spending etc. However, it is the inflation outlook which should be the most important.
As the year progresses, the greater the likelihood that we will see further signs of weaker demand, globally and domestically in Australia, as interest rate hikes take further effect. That slower pace of demand along with easing supply constraints also means that inflation is likely to ease further too. That would mean that the RBA would be comfortable leaving rates on hold.
Close to the end of the road
There are, of course, possible scenarios which could lead the RBA to hike. One of which would be if inflation surprised on the upside. Such an outcome would seem more probable in the second half of this year when the RBA expects a further easing of inflation. If the world or Australian economies prove more resilient than expected, we could see stickier inflation outcomes. By then, we would expect to see evidence of a higher unemployment rate, so resilience in the economy and the labour market would also justify further rate increases.
The balance of risks is towards a hike rather than a cut as being the next move. While inflation is likely to remain above target, until probably 2025, interest rates aren’t going down any time soon. However, signs of weaker household demand and softening conditions in the labour market suggest that interest rate hikes are already biting. Whether the RBA has more hikes in the bag, one thing is clear. The RBA is most certainly close to the end of its tightening cycle. And more likely than not, the RBA is done with hiking rates altogether.
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Janu isn’t afraid to step away from consensus and do things a bit differently. This has been the motivation for her to start Bitesized Economics in 2021. Bitesized Economics is an economic service providing independent analysis and content that is easily accessible, ‘bite-sized’ and easy to understand. The aim is to allow both financial experts and the everyday person to digest the important implications for their life and work.
