RBA - On hold for now
At its monetary policy meeting on 4 April, the Reserve Bank of Australia (RBA) decided to leave the Overnight Cash Rate (OCR) unchanged at 3.60% (Fig 1a). This represents the first pause by a major central bank and follows a cumulative 350bps of hikes over the past ten consecutive meetings. The RBA justified the pause by highlighting that “monetary policy operates with a lag” and a pause would “provide additional time to assess the impact of the increase in interest rates to date”. Nevertheless, the RBA retained its hawkish bias, noting that “the Board expects that some further tightening of monetary policy may well be needed to ensure that inflation returns to target”.
A pause not a pivot:
Following its March monetary policy meeting, the RBA highlighted it would monitor four key criteria including employment, inflation, retail trade and business surveys to determine the future path of interest rates. While the central bank noted that “the labor market remains very tight”, with unemployment close to a record low (Fig 2a) and wage prices trending higher; it also observed that “monthly CPI suggests that inflation has peaked”. Furthermore, “growth in the Australian economy has slowed” as lower house prices and cost of living pressures weigh on retail sales and business confidence (Fig 2b). Balancing these criteria with subdued outlook for the global economy and market volatility due to the recent banking stress in the US and Europe, the RBA decided a pause would be a sensible option.
Nevertheless, inflation remains well above the RBA’s 2-3% target range. The central bank also noted several factors could keep Australian inflation elevated, including low housing vacancy levels, rising rents, continued labor shortages and higher wage pressures. In addition, recent data suggests the property market is stabilizing and households still have substantial savings buffers. With the RBA forecasting inflation is unlikely to decline to 3% until mid-2025, it reconfirmed its “priority is to return inflation to target”.
The decision to pause was widely anticipated following the lower than expected monthly inflation print in February 2023 (Fig 2a). Majority of economists were calling for a pause and markets were only pricing a 45% probability of a rate hike. Nevertheless, following the announcement, the AUD weakened, bond yields declined and the curve flattened.
The RBA’s decision to “hold interest rates steady” was, in retrospect an easy one given the rapid pace of hikes over the past eleven months combined with “an environment of considerable uncertainty.” It also provides the central bank “with more time to assess the state of the economy and the outlook”, while retaining the optionality to hike further if necessary.
With inflation still significantly above the RBA’s target level and unemployment being close to record lows, additional rate hikes remain a distinct possibility. The RBA confirmed “that some further tightening of monetary policy may well be needed to ensure that inflation returns to target”. Key factors that the central bank will be monitoring include household spending, inflation and labor markets. The upcoming Statement on Monetary Policy in early May will be an important indicator of the central bank’s latest thinking; while the quarterly inflation and wage data, due in late April and mid-May, will be critical determinants of future interest rate decisions. With monthly meetings, the RBA can pivot quickly if necessary.
However, the central bank’s softer tone (switching from “will be needed” in the March statement to “may be needed” in the April statement) does suggest the bar to resume hiking is high and 3.60% may represent the peak of the current rate hiking cycle. Nevertheless, based on expectations currently priced into the market via an inverted BBSW yield curve (Fig 1b), it seems overly optimistic that the RBA will start cutting interest rates by the third quarter of 2023. Given the strong multiplier effect of Australian housing, it is unlikely the central bank is willing to risk restimulating the property market and allowing the economy to grow above trend until inflation is decisively contained.
For AUD cash investors, the RBA’s hawkish bias suggests the current, elevated level of interest rates is likely to remain for the foreseeable future. Segmenting cash and investing across a broad array of money market and ultra-short duration strategies present opportunities to achieve a relatively attractive and low volatility return on cash investments.