Dr Shane Oliver, Head of Investment Strategy & Chief Economist at AMP, discusses the cash rate.
Key points:- The RBA left its cash rate on hold at 4.1% for the third month in a row.
- This was in line with our own forecast, the consensus of economists and the money market’s expectation.
- The decision to hold makes sense given the run of softer data for jobs, wages and inflation in the last month and increasing signs that household spending is rapidly weakening.
- While the RBA retained its tightening bias given still high inflation and the still tight labour market, it remains milder than was the case earlier this year and data dependent.
- Our concern remains that the RBA has tightened more than necessary with a high (50%) risk of recession.
- As a result while the risk is still on the upside for the cash rate in the short term, our assessment is that the RBA probably won’t have to act on its tightening bias and we continue to see it cutting rates through next year.
The pause in interest rates over the last three months comes after the biggest interest rate hiking cycle (of 400 basis points over 14 months) since the late 1980s. As is well known the late 1980s tightening was a major contributor to the recession of the early 1990s. The risks to the household sector are arguably higher now because household debt to income levels are three times greater than they were in the late 1980s.
Source: RBA, AMP
In leaving the cash rate on hold at 4.1%, the RBA noted again that: interest rates have already been increased by 4%; higher rates are working to establish a “more sustainable balance between supply and demand”; uncertainty remains high, and staying on hold provides further time to assess the outlook.
Leaving rates on hold is consistent with the run of softer data for jobs, wages and inflation seen over the last month and increasing evidence that consumer spending is flagging. The RBA reiterated that recent data are consistent with inflation returning to target in late 2025, but we think it will be earlier.
The RBA remains concerned though that: inflation is still too high with many services prices rising briskly; the labour market remains “tight” (although it has softened this from being “very” tight); and that productivity growth needs to pick up.
As such it retained its guidance that “some further tightening of monetary policy [ie rate hikes] may be required to ensure that inflation returns to target in a reasonable timeframe”. It also reiterated that this will depend on how the data evolves and that it will continue to look closely at the global economy, household spending, inflation and the labour market. Its tightening bias remains softer than was the case earlier this year.
In particular, the RBA is continuing to give more weight to the downside risks to the economic outlook flowing from the lags with which monetary policy impacts the economy and uncertainties around household spending. And it also added a sentence on the increased uncertainty around the Chinese economy.
Even though rates were left on hold, the rate hikes since April last year mean that a variable rate borrower with a $600,000 mortgage will have seen $1300 a month added to their mortgage payments. That’s an extra $15,700 a year. Even if the borrower has managed to get a 0.5% discount to their mortgage rate it would amount to an extra $13,300 which is a big hit to household spending power. Many of those on fixed rates are now starting to experience that increase now in one jump.
Our view remains that the RBA has already done more than enough to slow the economy in order to rebalance demand and supply and bring inflation back to target. Rate hikes impact the economy with up to a one-year lag as it takes a while for the hikes to be passed through to borrowers and for them to adjust their spending. This time around the lag has likely been lengthened by savings buffers built up in the pandemic, the reopening boost, more than normal home borrowers locking in at 2% of so fixed mortgage rates in the pandemic and the highly competitive mortgage market which has meant that actual mortgage rates paid on outstanding mortgages have gone up by less than the cash rate. However, these protections are now wearing off.
We are now seeing increasing evidence that rate hikes are biting with falling real retail sales, the ABS’ Household Spending Indicator now indicating a fall on a year ago in July with both spending on goods and services slowing, a sharp fall in building approvals, slowing business investment plans, slowing GDP growth, retailers pointing to slowing demand in the recent profit reporting season, rising insolvencies, indications of a slowing jobs market, softer than expected wages growth and a faster than expected fall in inflation.
As a result of ongoing rate hikes, the risk of recession in the next year is very high. Consumer spending looks likely to start going backwards this quarter as the 4% plus cash rate is pushing debt servicing costs into record territory as a share of household income.
At the same time, while our Australian Inflation Indicator has picked up a bit lately with higher labour costs in business surveys it continues to point to a further rapid fall in inflation ahead.
Source: Bloomberg, AMP
Continuing to raise interest rates will only add to the already very high risk of unnecessarily knocking the economy into recession. At the very least the economy is likely to have slowed substantially by year end or early next year with unemployment starting to rise faster than the RBA is allowing for.
Given the lags involved and the increasing signs that monetary tightening is working it makes sense for the RBA to remain on hold so it can better assess the impact of the rate hikes.
While the near term risks for interest rates are still on the upside – don’t forget that Canada resumed rate hikes after a four month pause earlier this year - those risks have declined and future moves will remain data dependent. Absent much stronger than expected wages growth, a further drop in unemployment and/or a reversal of the downtrend in inflation, the RBA is expected to leave interest rates on hold for the rest of this year ahead of rate cuts next year.
We are continuing to allow for four rate cuts through 2024 starting in the first half as the economy and inflation slows further.
So soon-to-be Governor Michele Bullock should get a much easier run of it than Governor Lowe did on the interest rate front as her first interest rate move is likely to be a cut. The risk is that her main challenge may turn out to be trying to turn the economy back up again in the event of a hard landing or recession.
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