RBA May hike locked in
We reaffirm our view that the RBA will raise the cash rate 25bps to 4.35% next week.
- We reaffirm our expectation that the RBA Monetary Policy Board (MPB) will raise the cash rate a further 25bps at its May meeting, to 4.35%. Inflation was higher than the MPB was comfortable with prior to the Middle East conflict, spurring it to lift the cash rate in both February and March. The RBA doubled down on its views that the economy was tighter than full employment and needed to be restrained to get inflation back under control.
- Those rate hikes were based on data relating to the period before the war. While petrol prices have since reversed much of the 32.8% increase recorded in March, part of this was driven by the cut to excise, due to expire in a few months. Diesel prices – and thus freight costs – remain very elevated. The RBA could look through higher fuel prices if that was all that was happening, but it is not. Pass-through to other (non-fuel) prices is clearly starting, touching everything from building products to takeaway food if the reports we are receiving are any guide. The RBA will be hearing similar stories from firms in its liaison program.
- March would have been very early days for much pass-through to be evident in the CPI. For example, many of the price increases for building products we are aware of did not take effect until 1 April. Today’s CPI data nonetheless show scattered signs of pass-through to other prices. There were some promising signs in softer monthly prices of appliances and some other household goods. However, home-building and vehicle repair costs, along with downstream insurance inflation, all picked up in the month and quarter. Services related to AV, computing and telecommunications also increased in the month, which for telecommunications went against the run of recent months’ results.
- This is occurring in the context of a starting point where non-tradables and services inflation are already too high. At 0.8%qtr, the RBA’s preferred quarterly trimmed mean measure of inflation is still too high for the RBA to walk past, even though it was a touch lower than our pre-release expectation, consistent with the downside risks we flagged.
- Together with the spike in both consumer inflation expectations and business survey measures of costs and prices, the March inflation data will have the RBA’s inflation warning lights flashing bright red. The MPB will see an imperative to address high inflation despite the caution expressed by the minority voters in March.
- Some observers point to the demand-destruction higher fuel prices can unleash via the hit to real incomes, which will dampen inflation on its own eventually. This is plausible, but it will take too long to assuage an RBA facing an extended period of above-target inflation.
- Indeed, based on its communication so far, especially the March minutes, the MPB puts little weight on that argument. The minutes characterised the supply shock as ‘further exacerbating existing capacity pressures’, and the future demand destruction as just a possibility. This view flows from the RBA’s analysis that the economy is already too tight, as inferred from inflation already being above target. It is also taking signal from the income boost from higher LNG prices, but no disinflationary signal from exchange rate appreciation beyond what is already implied by the RBA’s own actions on rates.
- We also consider significant what the RBA has not communicated in recent weeks. When markets began pricing in multiple policy rate hikes by the ECB, Bank of England and Bank of Canada, senior officials at those central banks pushed back. Indeed, BoE Governor Bailey stated in an interview with Reuters that “markets had gotten ahead of themselves”. ECB President Lagarde used a speech on 25 March to highlight that the current shock was likely to be less inflationary than the energy shock in 2022 when Russia invaded Ukraine at a time that other supply chains were still recovering from pandemic disruption. The RBA has not pushed back in the same way. In addition to the higher starting point for inflation here, part of the reason seems to be that Australia is already seeing the pass-through to other prices that other central banks are still at the stage of watching for.
- All this adds up to the MPB wanting to tighten policy further. The refreshed forecast in the Statement on Monetary Policy will allow the RBA to set out its views of the inflation impulse from the war, making May a good opportunity to take, and explain, the next step.
- The outlook for the cash rate beyond May is necessarily less certain. We hold to our base case that there will be two further rate hikes after May, in June and August. The RBA’s experience last year, when underlying inflation popped back up almost immediately after it cut rates, will have nudged some within the RBA to the idea that the cash rate needs to be higher than its previous peak to really get inflation under control (for the technically-minded, their individual estimates of the neutral rate got revised up). While outwardly the RBA continues to characterise its strategy as being willing to be a bit less activist to hold onto the post-pandemic employment gains, most of the original architects of that strategy have left the building and those inclined to be more activist will have more influence.
- There is a chance that the RBA ends up doing less than our base case, if the voices on the MPB that counselled caution in March can sway other members, or if pass-through to non-fuel prices turns out to be less than current information suggests. However, we put less weight on this scenario given the starting point for domestically driven inflation.
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