Reserve Bank of Australia - A pivot to less hawkish
At its monetary policy meeting on the 7th of March, the Reserve Bank of Australia (RBA) hiked its Overnight Cash Rate (OCR) by 25bps to an eleven-year high of 3.60% (Fig 1a). The rate hike was widely anticipated following last month’s hawkish pivot. The central bank’s forward guidance remained hawkish, although the tone was more restrained, confirming that “further tightening of monetary policy will be needed to ensure that inflation returns to target”.
The RBA’s growth-inflation dilemma:
The RBA noted that recent economic data has shown signs of moderation as the cumulative impact of previous rate hikes (Fig 1b) weighs on housing demand, consumer confidence and business sentiment. The impact was also evident in the weaker than expected 0.5%q/q increase in fourth quarter 2022 GDP, which dragged the annual pace down to 2.7%y/y, as slower construction and consumption offset robust exports.
In contrast, while the RBA optimistically observed that “the monthly CPI indicator suggests inflation has peaked” (Fig 2), core inflation remains uncomfortably high with few signs of abating, as upward pricing pressures migrate from goods to services (which monthly inflation does not track). With employment remaining close to a 50-year low and many firms experiencing difficulty in hiring workers, wages also continue to climb with the latest quarterly wage price data growing at the fastest pace in over a decade (Fig 2b). Fortunately, higher immigration and a slight easing of labour market tightness allowed the central bank to be more sanguine about avoiding a price-wage spiral.
Immediately after the RBA’s announcement, the AUD weakened and bond yields declined and the yield curve flattened. Investors also lowered their expectations of future rate hikes and the potential terminal rate, while debate concerning the timing of any future pause also resurfaced.
Recognizing the dampening economic impact of its rapid rate hikes efforts, and noting that “the full effect of the cumulative increase in interest rates is yet to be felt in mortgage payments”, the RBA exercised cautious in its much-anticipated forward guidance. This was supported by signs that inflation has potentially peaked and “labor market... conditions have eased a little”.
While the RBA also pivoted to a more data dependent stance - paying “close attention” to key economic data in “assessing when and how much further interest rates need to increase”; nevertheless, it still confirmed its “resolute… determination to return inflation to target”.
For AUD cash investors, the latest interest rate hike should be welcome news, increasing cash rates to a decade high. Meanwhile, for investors with longer investment horizon, the upward sloping yield curve offers additional yield on longer tenor investments. Nevertheless, sticky inflation and central banks wary of the dangers of entrenched inflation suggest market and interest rate volatility are likely to remain high for the foreseeable future – implying a cautious approach to cash investments remains important.