The RBA, as anticipated, delivered a third consecutive 50bp rate hike in August, which we expect to be followed by a further 50bp move in September. That will have the cash rate at 2.35%, up from 0.1% at the start of May, a level which is nearing neutral, as assessed by the RBA. From there, the pace of rate hikes is likely to moderate, to increments of 25bps. We expect the cash rate to peak at 3.35% in February, upgraded from 2.60% previously - which is well into the contractionary zone. For the RBA, and other central banks, the key priority is to tame inflation, which we now expect to climb to over 7.5% by years’ end. Complacency around containing inflationary expectations is a trap that the RBA Board should avoid at all costs.
US FOMC Chair Powell has meanwhile indicated that the FOMC no longer feel behind the curve and that rate hikes are now a meeting-by-meeting proposition. The Committee needs to discern whether the inflation pulse is sustainably decelerating, while mindful that currently inflation is far too high. We anticipate that the fed funds rate will peak at 3.375% at year end, following a 50bp move in late September to 2.875%. News that the US economy contracted for a second consecutive quarter in June has reinforced both market volatility and the pull-back in long bond yields from the highs of June. By contrast, Europe surprised to the high side for the June quarter, with output growth printing at +0.7%. Currency markets have taken note of the relatively unfavourable growth performance and outlook for the US, marking down the US dollar. This brings the market more into line with our view. We continue to expect the Australian dollar to move higher late this year and into next year, lifting to US78¢ by end 2023 (rounded down from 80¢ previously).
Australia: We have marked down our output profile for 2023 and 2024, with growth now forecast to slow to 1% in 2023, downgraded from 2% previously, then recover to 2% in 2024, rounded down from 2.5%. Consumers and housing will lead the slowdown in the face of high inflation and high interest rates. We have also rounded up the 2022 growth forecast, to 4.4%, from 4%, to reflect a likely stronger outcome for the June quarter – with Q2 growth now a forecast 2%, with upside risks. A 1% growth pace for 2023 is well below trend, which we judge to be around 2.5%. Equally, such an outcome still compares favourably with previous significant economic shocks - most recently, the recession over the first half of 2020 at the outset of the pandemic. A number of the positives that are driving strong economic momentum in mid-2022, a particularly strong labour market and a sizeable saving buffer of households, will help to cushion the 2023 downturn.
Commodities: Commodity price volatility has been greater than usual with our broad export price index down 17% from early June with larger declines in iron ore (-22%) and met coal (-53%) partially offset by rising thermal coal. We are still working thought these shifting trends in supply and demand to see if we need to significantly revise our medium term commodity prices forecast track. Till then we have benchmarked most commodities to current prices and hold them there through to the end of the year.
Global FX markets: Having become extremely stretched compared to history, the US dollar has made a hasty retreat over the past month. With key global risks now seen to be as much of a concern for the US as other developed nations, we expect this trend to persist over the coming 18 months, albeit in a volatile manner and with clear event risk emanating from Europe.
New Zealand: We have revised up our forecast for New Zealand’s Official Cash Rate and now expect a peak of 4.00% by the end of this year. Inflation has risen to a 32-year high and it is set to remain elevated for some time yet, with strong demand a key factor boosting prices. Mortgage rate fixing has blunted the impact of rate hikes thus far, but higher interest costs will become an increasing drag on household spending over the coming months.
United States: Recent data has forced the FOMC to recognise that their view of the risks to the outlook must shift from a sole focus on inflation to a balanced view of both activity and prices. Without the full effect of policy tightening and real income loss having been felt, the economy entered a technical recession in Q2. We worry that this is the beginning of a long economic stagnation.
China: While Q2 GDP was as weak as the market anticipated, available partial data makes clear the hit from COVID-zero has been restricted to the three months to June and also that the recovery is continuing at pace. Note though that, given the virulence of COVID-19 and the residential construction sector’s poor health, near-term risks remain.
Europe: The ECB kicked off their interest rate tightening cycle with a surprisingly hawkish 50bp lift as headline inflation continues to breach historic highs and the inflationary pressures on the wider consumption basket broadens. Although Q2 GDP surprised to the upside, material downside risks to growth remain. We expect the ECB to look through these risks and raise the main refinancing rate to a peak of 1.50% by year end in order to combat the formidable inflation challenge facing the Euro Area.
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