RBA to hike in February on second uncomfortably high quarterly inflation read
December quarter inflation had the casting vote and voted ‘Yes, hike’. RBA to raise cash rate at February meeting to 3.85%. Further rate hikes possible but ‘one-and-done’ as a base case.
- When the economy is close to full employment and full capacity utilisation, it is hard to know which side of the line it is on. Inflation outcomes are the best guide in this situation. This is one reason why inflation gets the ‘casting vote’ at the RBA’s February meeting. With trimmed mean as the clearest signal of the underlying inflation trend, its 0.9%qtr, 3.4%yr quarterly result in the December quarter implies that the RBA is likely to raise rates at the February meeting.
- Looking beyond the next meeting, Australia’s inflation outlook got murkier in recent weeks. A higher starting point is implied by the September and December quarter data, a stronger labour market and a clear upswing in consumer spending. Further out, though, higher market pricing for interest rates and a noticeably higher exchange rate should dampen the forecast trajectory relative to the November SMP round. The RBA’s judgement on how these factors balance out will be key to the rates outlook beyond the next meeting.
- A cash rate increase next week might not necessarily be followed up with a sequence of moves. Nobody doubted that a cash rate in the 4s last year was restrictive, and the amount of disinflation required from here is not large. Expect a ‘wait-and-see’ stance, with a clear willingness to follow up to be communicated following the meeting.
As we highlighted last week, it really shouldn’t be that the RBA decision comes down to one number. With the other data finely balanced, though, the quarterly inflation print gets the casting vote. Today’s data voted for a rate hike. This means that we now expect that the RBA to react by raising the cash rate at its February meeting. September quarter’s high reading could be looked through on the grounds that some of the pick-up was temporary. This was also our view. Two higher-than-desired quarters are harder to look through, however, even allowing for the uncertainties involved in the new CPI collection.
After preparing the ground in recent weeks for a rate hike, we believe the RBA Monetary Policy Board will follow through on these warnings with a 0.25ppt increase in the cash rate to 3.85%.
There is still a small chance they hold, and we expect the Board to debate the merits of holding versus raising the cash rate at the meeting. We are mindful of the messaging via the media that the RBA would hike if trimmed mean inflation remained above its 2–3% target and was drifting further away from the desired midpoint (our emphasis). The run of quarterly data might not quite meet the second part of that test, though there are definitely ways to construe the data to argue that it does. There are also arguments to be cautious given that the new monthly collection has made the inflation data harder to interpret. With market and public expectations already primed, though, the Board is likely to see little reason to wait.
The key quarterly trimmed mean inflation rate (the pre-October method now buried in an appendix, given the current calculation methods are afflicted with seasonality-related uncertainty) printed higher than Westpac expected, at 0.9%qtr, 3.4%yr. This is too high for the RBA’s comfort, even though it is a little lower than the September quarter result. Its November forecast was for quarterly-basis trimmed mean inflation to print at 3.2%yr. Other measures of underlying inflation were likewise too high.
The monthly data was a bit more of a mixed bag. Seasonally adjusted headline inflation was in line with our year-ended view (PDF 901KB) (3.7%yr). Housing-related inflation was more benign than expected in December, with both rent inflation and home-building inflation below our year-ended forecasts. Rent inflation continues to moderate, and the run of monthly data on home-building costs looks like inflation in that category might have peaked.
Some other categories were above our expectations, though, if only a little, and this was enough to push the trimmed mean – both monthly and quarterly – higher than our calculations implied. The result was also clearly above what the RBA would have needed to see to hit their November forecast, as noted above.
Looking beyond the next meeting, Australia’s inflation outlook got murkier in recent weeks. A higher starting point is implied by the September and December quarter data, stronger labour market and clear upswing in consumer spending. Further out, though, higher market pricing for interest rates and a noticeably higher exchange rate should dampen the forecast trajectory relative to the November SMP round, steepening a downward slope in the inflation forecasts.
Whether the RBA actually incorporates this downside is another matter. The RBA has recently been working on the basis that the Australian economy is trapped in the slow lane, hemmed in by slow-growing supply. As we have previously highlighted, this working assumption rests on further assumptions about productivity growth and population growth that are both on the low side of reasonable estimates. Today’s data will only solidify the RBA’s view, and we expect renewed emphasis on this narrative in the next Statement on Monetary Policy.
We do not, however, assume this necessarily means a sequence of back-to-back hikes. An increase in the cash rate next week will put policy in an unambiguously restrictive position, a point on which there has been some debate recently. The peak cash rate is only half a point higher than next week’s expected outcome. And with measures of underlying inflation in the bottom half of the 3s, the amount of disinflation needed to get back to the 2½% target midpoint is relatively modest.
If inflation remains uncomfortably high in coming quarters, the Board will act again. However, further moderation over coming quarterly inflation prints, together with benign reads on the labour market, might see the Board wait for some time before moving the cash rate again. Since this is our current view of the inflation outlook, pending a full review, our base case is for a single hike as the most likely outcome, followed by an extended pause. Depending on the time elapsed and pace of disinflation from here, the next move could be in either direction.
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