RBA Changes Pace

The Reserve Bank of Australia (RBA) Board increased the cash rate by 0.25% to 2.60% at its October meeting.

The move was a change of pace following four successive 0.50% increases. The change of pace is recognition that a lot of the heavy lifting has been done, whilst balancing the competing narratives of maintaining their inflation fighting credibility; and the lagged effect on the economy and household of successive large rate increases.

The RBA maintained that global factors explain much of the inflation impact locally, but that strong domestic demand is playing its role as our economy struggles to meet this demand. The Bank believes CPI inflation will be around 7.75% over 2022, before falling to a little above 4% over 2023 and around 3% over 2024. The Board will continue to pay close attention to both labour costs and the price-setting behaviour of firms for the period ahead in light of these inflation forecasts.

Outside of that, the Board is focused on:

1. the uncertainty in the outlook for the global economy which they acknowledge has deteriorated recently
2. how household spending in Australia responds to tighter financial conditions given the impact on household budgets
3. falling consumer confidence and house prices, in contrast to the large financial buffers many households have built up

The slowdown in rate rises gives the RBA added flexibility to potentially elongate their rate hiking cycle and/or add some pauses to their rate hiking cycle in the period ahead, if they prefer to wait for more data to come through. In saying that, if they proceed with two more hikes to round out the calendar year, this will take the cash rate to a little over 3% which might be restrictive enough depending on prevailing economic conditions. If this turns out to be correct, the critical question then becomes, how long rates need to remain at these restrictive levels to bring inflation closer to the RBA’s comfort levels.

Post the announcement, Australian government bond yields fell (prices higher), AUD/USD bounced before falling away again, and Australian equities were higher, with their best day in 2 years.