RBA stick to 0.25% increases
The Reserve Bank of Australia (RBA) increased the cash rate to 2.85% (from 2.6%) at the November meeting. The market had largely expected this, although some economists had expected a 0.5% increase on the back of stronger than expected inflation for the third quarter this year.
The RBA have pointed to some changes in their forecasts, including a downgrade to their economic growth profile and an associated increase in the expected unemployment rate. We believe this dynamic will keep the RBA on a more cautious path, compared to some of their international peers.
One of the key concepts within monetary policy is the neutral rate of interest, more commonly referred to as r-star. R-star is the interest rate at which monetary policy is neither a headwind or tailwind to the economy. Unfortunately, we cannot directly observe where r-star is, but economic modelling and market pricing can give us a good guide. The RBA recently gave a speech on this exact topic (can be found here), where they indicated that their best estimate of r-star is under 3.5%. The reason that this is important is because it means that monetary policy is now very close to restrictive in Australia.
The reason that this is important is that the Australian economy is now facing a slowdown in global growth and a small headwind from monetary policy. There is a lot of discussion in the press about a ‘hard versus soft landing’ – that is, can central banks raise interest rates without causing a recession. We believe that the RBA’s more cautious approach means that there is still a decent case for a soft landing, especially if the RBA do not raise rates to the level that the market expects.
Along with their nervousness on the global economic outlook and the health of the consumer, the RBA are also focused on the risks around a wage-price spiral. As of now, there is little evidence of any wage-led price spiral. In fact, Australian wage growth has been more tepid than other countries. The Australian Bureau of Statistics will release the wage data for Q3 on the 16th November, which will be an important watchpoint for the RBA stance.
Outside of a very large surprise from the wage data, we believe that the RBA are likely to raise rates again by 0.25% at the December meeting. The RBA do not meet in January, so the market and the RBA will be able to fully digest incoming news about the health of the global economy, particularly given the challenges that Europe might face through winter, before the next meeting.
We maintain our view that Australian government bonds look relatively attractive compared to other developed economies (excluding the United States), given decent valuations. Also, we believe the RBA are likely to underwhelm market expectations on rate rises through 2023.