In Brief

• At its monetary policy meeting on August 2, the Reserve Bank of Australia (RBA), in-line with expectations, hiked the base rate by 50bps to 1.85%, taking total rate hikes to 175bps over the past 4-months.
  
  
• Despite upward revisions to its inflation and employment forecasts, the surprise economic growth downgrade combined with the RBA affirming “it is not on a pre-set path” to interest rate normalization was broadly perceived as being less hawkish.
  
  
• Nevertheless, the RBA confirmed that “further steps in the process of normalizing monetary conditions over the months ahead” are still necessary to achieve the central bank’s goals of low inflation and steady economic growth.

At its monetary policy meeting on August 2, the Reserve Bank of Australia (RBA), in-line with expectations, hiked base rates by 50bps to 1.85% (Exhibit 1). This was the fourth hike in the current cycle and the third 50bps hike as the central bank affirmed its goal to “return inflation to the 2-3 % range over time and keeping the economy on an even keel”.

Exhibit 1: RBA base rates have returned to the highest level in over 6-years, while market driven yields remain elevated

Source: RBA, Bloomberg & J.P. Morgan Asset Management, as at August 2 2022.

A narrow, clouded path:

Recent economic data has been robust with the value of exports hitting a new record high while domestic consumption has rebounded as the last Covid restriction were removed. The RBA confirmed the “economy is expected to grow strongly this year”, yet they also believe the path to achieving their goal is “clouded in uncertainty”. A combination of a weaker global outlook and escalating domestic concerns - including higher interest rates, falling house prices and a decline in consumer confidence (Exhibit 2) - are “key sources of uncertainty”, triggered a downward revision to the central bank’s 2022 GDP growth forecast to 3.25% (from 4.25% previously).

Exhibit 2: House prices have fallen sharply, albeit from recent record highs, while business and consumer confidence has declined

Source: Core-Logic, Westpac, NAB, Bloomberg & J.P. Morgan Asset Management, as at August 2 2022.

In contrast, with Q2 2022 inflation jumping to a 21-year peak of 6.1% year-on-year (Exhibit 3) while June unemployment declined to a 48-year low of 3.5% (Exhibit 3), the RBA was forced to upgrade these projections. Inflation is now expected “to be around 7.75% over 2022” (from 7% previously and in-line with the government’s recent prediction), before declining to 4% in 2023 and 3% in 2024. Meanwhile the RBA expects a further decline in unemployment this year before a modest weakening to end 2024 at around 4%. The central bank also believes that with job vacancies and job ads currently at very high levels, wage growth will increase “as firms compete for staff in a tight labor market”.

Exhibit 3: The RBA expects inflation, already at a multi-decade high, to climb further; while unemployment is predicted to remain around current levels

Source: Bloomberg & J.P. Morgan Asset Management, as at August 2 2022.

The path to normalization:

Balancing these conflicting economic trends, the RBA justified its third outsized rate hike as necessary to “bring inflation back to target” and a “further step in the normalization of monetary policy”.

Nevertheless, the surprise economic growth downgrade – albeit to a still above trend level - combined with the RBA affirming “it is not on a pre-set path” to interest rate normalization was broadly perceived as being less hawkish. Longer tenor bond yields and the AUD declined following the rate decision as investors partially unwound the more aggressive future rate hike expectations relative to RBA forecasts.

However, the recently published July monetary policy meeting minutes clarified the central banks views on the neutral real interest rate, with Governor Lowe subsequently stating “that the neutral nominal rate is at least 2.5%”. This suggests that additional rates hikes are still necessary to achieve the central bank’s goals – although the pace of these hikes as well as the terminal rate are now more uncertain.

Investor implications:

The continued rapid increase in base rates remains positive news for AUD cash investors, while the recent flattening of the yield curve suggests ultra-short duration strategies may now offer value for reserve and strategic cash balances with longer investment horizons. Meanwhile, “incoming data and the Board’s assessment of the outlook for inflation and the labour market” will remain critical factors in determining the size and timing of future rate increases.

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